UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission File Number: 1-15781
BERKSHIRE HILLS BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3510455
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
24 North Street, Pittsfield, Massachusetts 01201
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (413) 443-5601
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of each exchange
on which registered:
Common Stock, par value $0.01 per share American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes |X| No |_|
The market value of the voting and non-voting common equity held by
non-affiliates was $147.2 million, which was computed by reference to the price
at which the common equity was last sold as of the last business day of the
registrant's most recently completed second fiscal quarter. Solely for purposes
of this calculation, the shares held by directors and officers of the registrant
are deemed to be held by affiliates.
As of February 25, 2003, the registrant had 6,014,862
shares of common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Proxy Statement for the Annual Meeting of Stockholders. (Part III)
INDEX
PART I .................................................................... 2
ITEM 1. BUSINESS ....................................................... 2
ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT .......................... 30
ITEM 2. PROPERTIES ..................................................... 32
ITEM 3. LEGAL PROCEEDINGS .............................................. 32
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ............ 33
PART II ................................................................... 33
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS ....................................................... 33
ITEM 6. SELECTED FINANCIAL DATA ........................................ 33
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS ..................................... 36
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .... 45
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA ..................... 47
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE ...................................... 97
PART III .................................................................. 97
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ............ 97
ITEM 11. EXECUTIVE COMPENSATION ........................................ 97
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS ................... 97
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ................ 97
PART IV ................................................................... 98
ITEM 14. CONTROLS and PROCEDURES ....................................... 98
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K ..................................................... 98
-1-
PART I
ITEM 1. BUSINESS
General
Berkshire Hills Bancorp, Inc. (the "Company" or "Berkshire Hills"), a
Delaware corporation, was organized in January 2000 for the purpose of becoming
the holding company for Berkshire Bank (the "Bank") upon the conversion of the
Bank's former parent holding company, Berkshire Bancorp, from the mutual to
stock form of organization on June 27, 2000. The Company owns all of the
outstanding shares of the Bank. The Company has no significant liabilities.
Management of the Company and the Bank are substantially similar and the Company
neither owns nor leases any property, but instead uses the premises, equipment
and furniture of the Bank. Accordingly, the information set forth in this
report, including the consolidated financial statements and related financial
data, relates primarily to the Bank.
The Bank is regulated by the Massachusetts Division of Banks and the
Federal Deposit Insurance Corporation (the "FDIC"). The Bank's deposits are
insured to the maximum allowable amount by the Bank Insurance Fund (the "BIF")
of the FDIC and the Depositors Insurance Fund (the "DIF"). Berkshire Bank has
been a member of the Federal Home Loan Bank system since 1973.
Berkshire Bank is a community bank that accepts retail deposits from the
general public in the areas surrounding its 11 full service banking offices and
uses those funds, together with funds generated from operations and borrowings,
to originate residential mortgage loans, commercial business and real estate
loans and consumer loans, primarily indirect automobile loans. Berkshire Bank
primarily holds the loans that it originates for investment, but occasionally
sells some of its loans, including automobile and fixed-rate mortgage loans, in
the secondary market. Berkshire Bank also invests in U.S. Government and Agency
securities, mortgage- and asset-backed securities, including real estate
mortgage investment conduits and collateralized mortgage obligations, debt and
equity securities and other permissible investments. Berkshire Bank's revenues
are derived principally from the generation of interest and fees on loans
originated and, to a lesser extent, interest and dividends on its investment
securities. Berkshire Bank's primary sources of funds are deposits, principal
and interest payments on loans and securities and advances from the Federal Home
Loan Bank of Boston.
Market Area
Berkshire Bank is headquartered in Pittsfield, Massachusetts, in Berkshire
County. Berkshire Bank's primary deposit gathering and lending areas are
concentrated in the communities surrounding its 11 full service banking offices
located in Berkshire County. However, Berkshire Bank also makes loans throughout
western Massachusetts, northern Connecticut, eastern New York and southern
Vermont.
Berkshire County, the western-most county in Massachusetts, is
approximately two and one-half hours from both Boston and New York City.
Berkshire County borders Vermont, Connecticut and New York. Berkshire County has
experienced a shift in its economy as manufacturing jobs have been replaced with
service related jobs, primarily in tourism, social service and health care.
Other than Berkshire Bank, the major employers in the area include Berkshire
Life Insurance Company of America, Crane & Company, GE Plastics, Kay Bee Toys,
Berkshire Health Systems, General Dynamics Defense Systems, Mead Corporation and
several institutions of higher education.
Competition
The Bank faces intense competition for the attraction of deposits and
origination of loans in its primary market area. Berkshire Bank's most direct
competition for deposits comes from one large credit union in the area, which
has a competitive advantage as credit unions do not have to pay state or federal
taxes. Additionally, Berkshire Bank faces competition for deposits from several
commercial and savings banks operating in its primary market area and, to a
lesser extent, from other financial institutions, such as brokerage firms,
insurance companies and the mutual fund industry as customers seek alternative
sources of investment for their funds. Berkshire Bank also faces significant
competition for investors' funds due to their direct purchase of short-term
money market securities and other corporate and government securities. Berkshire
Bank faces competition for loans from the significant number of traditional
financial institutions, primarily savings banks and commercial banks in its
market area, as well as the mortgage companies and mortgage brokers operating in
its primary market area. The increase of Internet accessible financial
institutions which solicit deposits and originate loans on a nationwide basis
also increases competition for Berkshire Bank's customers. Additionally,
competition has increased as a result of regulatory actions and legislative
changes, most notably the enactment of the Gramm-Leach-Bliley Act of 1999. These
changes have eased restrictions on interstate banking and the entrance into the
financial services market by non-depository and non-traditional financial
services providers, including insurance companies, securities brokerage and
underwriting firms and specialty financial services companies (such as
Internet-based providers).
- 2 -
Lending Activities
General. The types of loans that Berkshire Bank may originate are limited
by federal and state laws and regulations. Interest rates charged by Berkshire
Bank on loans are affected principally by Berkshire Bank's current
asset/liability strategy, the demand for such loans, the supply of money
available for lending purposes and the rates offered by competitors. These
factors, in turn, are affected by general and economic conditions, monetary
policies of the federal government, including the Federal Reserve Board,
legislative tax policies and governmental budgetary matters.
Loan Portfolio Analysis. The following table sets forth the composition of
Berkshire Bank's loan portfolio in dollar amounts and as a percentage of the
portfolio at the dates indicated.
At December 31,
---------------------------------------------------------------------------
2002 2001 2000
----------------------- ----------------------- -----------------------
Percent Percent Percent
of of of
Amount Total Amount Total Amount Total
--------- ------ --------- ------ --------- -------
(Dollars in thousands)
Real estate loans:
One- to four-family $ 246,938 34.16% $ 240,852 29.99% $ 249,440 31.44%
Commercial 119,198 16.48 84,741 10.55 63,871 8.05
Multi-family 14,920 2.06 13,183 1.65 15,699 1.98
Construction and land
development 17,627 2.44 22,936 2.86 14,290 1.80
--------- ------ --------- ------ --------- ------
Total real estate loans 398,683 55.14 361,712 45.05 343,300 43.27
--------- ------ --------- ------ --------- ------
Consumer loans:
Home equity lines of credit 40,713 5.63 34,439 4.29 34,471 4.34
Automobile 105,047 14.53 215,964 26.90 230,648 29.08
Other 13,291 1.84 20,640 2.56 18,014 2.27
--------- ------ --------- ------ --------- ------
Total consumer loans 159,051 22.00 271,043 33.75 283,133 35.69
--------- ------ --------- ------ --------- ------
Commercial loans 165,447 22.86 170,230 21.20 166,956 21.04
--------- ------ --------- ------ --------- ------
Total loans 723,181 100.00% 802,985 100.00% 793,389 100.00%
====== ====== ======
Net deferred loan origination
costs 41 172 232
Unamortized discount on
purchased loans (200) (203) --
Allowance for loan losses (10,308) (11,034) (10,216)
--------- --------- ---------
Total loans, net $ 712,714 $ 791,920 $ 783,405
========= ========= =========
At December 31,
-------------------------------------------------
1999 1998
---------------------- -----------------------
Percent Percent
of of
Amount Total Amount Total
--------- ------ --------- -------
(Dollars in thousands)
Real estate loans:
One- to four-family $ 245,240 36.39% $ 220,612 36.36%
Commercial 46,419 6.89 51,598 8.50
Multi-family 14,793 2.20 15,393 2.54
Construction and land
development 12,534 1.86 12,821 2.11
--------- ------ --------- ------
Total real estate loans 318,986 47.34 300,424 49.51
--------- ------ --------- ------
Consumer loans:
Home equity lines of credit 33,168 4.92 31,628 5.21
Automobile 164,862 24.46 134,616 22.19
Other 10,706 1.59 5,933 0.98
--------- ------ --------- ------
Total consumer loans 208,736 30.97 172,177 28.38
--------- ------ --------- ------
Commercial loans 146,196 21.69 134,115 22.11
--------- ------ --------- ------
Total loans 673,918 100.00% 606,716 100.00%
====== ======
Net deferred loan origination
costs 170 44
Unamortized discount on
purchased loans -- --
Allowance for loan losses (8,534) (7,589)
--------- ---------
Total loans, net $ 665,554 $ 599,171
========= =========
Real Estate Lending
One- to Four-Family Real Estate Loans. One of Berkshire Bank's primary
lending activities is to originate loans secured by one- to four-family
residences located in its primary market area. At December 31, 2002, $246.9
million, or 34.2%, of Berkshire Bank's total loans consisted of one- to
four-family mortgage loans. Of the one- to four-family loans outstanding at that
date, 47.3% were fixed-rate mortgage loans and 52.7% were adjustable-rate loans.
Berkshire Bank originates fixed-rate fully amortizing loans with
maturities of 15, 20 and 30 years. Management establishes the loan interest
rates based on market conditions. Berkshire Bank offers mortgage loans that
conform to Fannie Mae and Freddie Mac guidelines. In addition, Berkshire Bank
offers a jumbo loan product, which presently are loans in amounts over $400,000.
Berkshire Bank generally originates loans for its own portfolio, but
occasionally sells some fixed-rate One- to four-family loans in the secondary
market. The determination of whether to sell loans is reviewed periodically by
management in response to changes in prevailing market interest rates and
liquidity needs.
Berkshire Bank also currently offers adjustable-rate mortgage loans, with
an interest rate based on the one year, three year or five year Constant
Maturity Treasury index, which adjust every one, three or five years from the
outset of the loan, with terms of up to 30 years. Interest rate adjustments on
such loans range from 2% to 5% during any adjustment period and are limited to
no more than 6% over the life of the loan.
- 3 -
Adjustable-rate mortgage loans help reduce Berkshire Bank's exposure to
changes in interest rates. There are, however, unquantifiable credit risks
resulting from the potential of increased costs due to changed rates to be paid
by borrowers. During periods of rising interest rates the risk of default on
adjustable-rate mortgage loans increases as a result of repricing and the
increased payments required to be made by borrowers. In addition, although
adjustable-rate mortgage loans allow Berkshire Bank to increase the sensitivity
of its asset base to changes in interest rates, the extent of this interest
sensitivity is limited by the periodic and lifetime interest rate adjustment
limits. Because of these considerations, Berkshire Bank has no assurance that
yields on adjustable-rate mortgage loans will be sufficient to offset increases
in Berkshire Bank's cost of funds during periods of rising interest rates. These
risks have not had a material adverse effect on Berkshire Bank to date.
Berkshire Bank underwrites one- to four-family residential mortgage loans
with loan-to-value ratios of up to 100% on a one- to two-family primary
residence, up to 90% on a three- to four-family primary residence or a vacation
home, and up to 75% on a condominium. A borrower is required to obtain private
mortgage insurance on loans that exceed 80%, or 75% in the case of a
condominium, of the appraised value or sales price, whichever is less, of the
secured property. Berkshire Bank also generally requires fire, casualty, title,
hazard insurance and, if appropriate, flood insurance to be maintained on all
properties securing real estate loans made by Berkshire Bank. An independent
licensed appraiser generally appraises all properties.
To provide financing for low- and moderate-income families, Berkshire Bank
offers Federal Housing Authority, Veterans Administration and Massachusetts
Housing Finance Agency residential mortgage loans to qualified individuals with
adjustable- and fixed-rates of interest and terms of up to 30 years. Such loans
may be secured by one- to four-family residential property and are underwritten
using modified underwriting guidelines. Berkshire Bank also participates in the
Good Samaritan Home Ownership Program, which is a non-profit venture established
to advise and assist low- and middle-income families in the purchase of their
first home in Berkshire County. Qualified individuals can obtain a 30-year
fixed-rate mortgage loan on a one- to four-family, owner occupied property.
Construction and Land Development Loans. At December 31, 2002,
construction and land development loans totaled $17.6 million, or 2.4% of
Berkshire Bank's total loan portfolio, of which $6.6 million were residential
construction and land development loans and $11.0 million were commercial
construction and land development loans. At December 31, 2002, the unadvanced
portion of construction and land development loans totaled $19.2 million.
Berkshire Bank originates construction and land development loans to
individuals for the construction and acquisition of personal residences.
Berkshire Bank's residential construction and land development loans generally
provide for the payment of interest only during the construction phase, which is
usually twelve months. At the end of the construction phase, the loan converts
to a permanent mortgage loan. Loans can be made with a maximum loan to value
ratio of 85%, provided that the borrower obtains private mortgage insurance on
the loan if the loan balance exceeds 80% of the appraised value or sales price,
whichever is less, of the secured property. At December 31, 2002, the largest
outstanding residential construction and land development loan commitment was
for $1.4 million. Construction and land development loans to individuals are
generally made on the same terms as Berkshire Bank's one- to four-family
mortgage loans.
Before making a commitment to fund a residential construction and land
development loan, Berkshire Bank requires an appraisal of the property and
planned improvements by an independent licensed appraiser. Berkshire Bank also
reviews and inspects each property before disbursement of funds during the term
of the construction and land development loan. Loan proceeds are disbursed after
inspection based on the percentage of completion method.
Berkshire Bank also makes construction and land development loans for
commercial development projects, including multi-family commercial properties,
single-family subdivisions and condominiums. These loans generally have an
interest only phase during construction then convert to permanent financing.
Disbursement of funds is at the sole discretion of Berkshire Bank and is based
on the progress of construction. The maximum loan to value ratio for these loans
depends upon the type of commercial development project being undertaken, but
generally will not exceed 80%. At December 31, 2002, the largest commercial
construction and land development commitment was $4.3 million, of which $4.1
million was outstanding, for the renovation and upgrade of a 230-acre property
in Stockbridge, Massachusetts. This loan was performing according to its terms
at December 31, 2002.
Berkshire Bank also originates land loans to local contractors and
developers for the purpose of making improvements thereon, or for the purpose of
holding or developing the land for sale. Such loans are secured by a lien on the
property, have loan to value ratios that are limited to 70% of the value of the
land used for residential development and 65% of the value of the land used for
commercial development (based on the lower of the acquisition price or the
appraised value of the land). Land loans are offered with a term of three years
in which only interest is required to be paid each month. A balloon payment for
the principal plus any accrued interest is due at the end of the three year
period. Berkshire Bank's land loans are generally secured by property in its
primary market area. Berkshire Bank generally requires title insurance and, if
applicable, either a hazardous waste survey or environmental insurance coverage.
Construction and land development financing is generally considered to
involve a higher degree of credit risk than long-term financing on improved,
owner-occupied real estate. Risk of loss on a construction loan is dependent
largely upon the accuracy of the initial estimate of the property's value at
completion of construction compared to the estimated cost (including interest)
of construction and other assumptions. If the estimate of construction cost
proves to be inaccurate, Berkshire Bank may
- 4 -
be required to advance funds beyond the amount originally committed to protect
the value of the property. Additionally, if the estimate of value proves to be
inaccurate, Berkshire Bank may be confronted with a project, when completed,
having a value which is insufficient to assure full repayment.
Multi-Family and Commercial Real Estate Loans. Berkshire Bank originates
multi-family and commercial real estate loans that are generally secured by five
or more unit apartment buildings and properties used for business purposes such
as small office buildings, industrial, healthcare, lodging or retail facilities
primarily located in Berkshire Bank's primary market area. Berkshire Bank's
multi-family and commercial real estate loans may be made in amounts of up to
80% of the appraised value of the property or the selling price, whichever is
less. Loans secured by single-family subdivisions and condominium projects may
be made in amounts of up to 75% and 70%, respectively, of the appraised value of
the property or selling price, whichever is less. Berkshire Bank's multi-family
and commercial real estate loans may be made with terms of up to 20 years and
substantially all of which are originated with interest rates that adjust
periodically and are generally indexed to Berkshire Bank's base rate. In
reaching its decision on whether to make a multi-family or commercial real
estate loan, Berkshire Bank considers the net operating income of the property,
the borrower's expertise, credit history and profitability and the value of the
underlying property. In addition, with respect to commercial real estate rental
properties, Berkshire Bank will also consider the term of the lease and the
quality of the tenants. Berkshire Bank has generally required that the
properties securing these real estate loans have debt service coverage ratios
(the ratio of earnings before debt service to debt service) of at least 1.25x.
Environmental surveys or environmental insurance coverage are generally required
for commercial real estate loans. Additionally, in larger real estate projects,
it is recommended that a feasibility study be obtained. A feasibility study is
particularly important with respect to multi-family housing projects,
hotel/motel construction and health care facilities. Generally, multi-family and
commercial real estate loans made to corporations, partnerships and other
business entities require personal guarantees by the principals. The largest
multi-family or commercial real estate loan relationship in Berkshire Bank's
portfolio at December 31, 2002 consisted of three loans to related health care
facilities in Massachusetts totaling $7.8 million. All loans were performing
according to their terms at December 31, 2002.
Loans secured by multi-family and commercial real estate properties
generally involve larger principal amounts and a greater degree of risk than
one- to four-family residential mortgage loans. Because payments on loans
secured by multi-family and commercial real estate properties are often
dependent on the successful operation or management of the properties, repayment
of such loans may be affected by adverse conditions in the real estate market or
the economy. Berkshire Bank seeks to minimize these risks through strict
adherence to its underwriting standards.
Consumer Lending
Automobile Lending. At December 31, 2002, automobile loans totaled $105.0
million, or 14.5% of Berkshire Bank's total loans and 66.0% of consumer loans.
The Bank offers fixed-rate automobile loans on a direct and indirect basis with
terms of up to 72 months for new and recent model used cars and up to 66 months
for older model used cars. Berkshire Bank generally will make such loans up to
100% of the retail value shown in the NADA Used Car Guide. The interest rates
offered differ depending on the age of the automobile and current interest rates
offered by competitors.
Berkshire Bank began offering indirect automobile loans through automobile
dealers over ten years ago. Currently, Berkshire Bank maintains contractual
relationships with over 80 new and used car dealers throughout western
Massachusetts, northern Connecticut, eastern New York and southern Vermont.
Included among these automobile loans has been the origination of lower credit
quality or sub-prime automobile loans. However, due to increased delinquencies
on these loans in recent years, due in part to the decline in the local,
regional and national economies, in 2001 management determined to decrease its
emphasis on lower quality or sub-prime automobile loans and attempt to reduce
the overall size of the automobile loan portfolio. This process was accelerated
through the sale of $69.7 million of indirect sub-prime automobile loans in
2002. At December 31, 2002, $18.4 million of lower quality or sub-prime
automobile loans, representing 17.5% of automobile loans, or 2.5% of total
loans, remained.
Home Equity Lines of Credit and Other Consumer Loans. Berkshire Bank
offers home equity lines of credit secured by owner-occupied one- to four-family
residences. At December 31, 2002, home equity lines of credit totaled $40.7
million, or 5.6% of Berkshire Bank's total loans and 25.6% of consumer loans.
Additionally, at December 31, 2002, the unadvanced amounts of home equity lines
of credit totaled $41.3 million. The underwriting standards employed by
Berkshire Bank for home equity lines of credit include a determination of the
applicant's credit history, an assessment of the applicant's ability to meet
existing obligations and payments on the proposed loan and the value of the
collateral securing the loan. Home equity loans will not be made if the
borrower's first mortgage payment, monthly real estate payment and amortized
equity line payment exceed 25% of the borrower's gross monthly income.
Additionally, the borrower's monthly debt service cannot exceed 35% of the
borrower's gross monthly income. Home equity lines of credit have adjustable
rates of interest which are indexed to the prime rate as reported in The Wall
Street Journal. Generally, the maximum combined loan-to-value ratio on home
equity lines of credit is 80% for loans up to $200,000 and 60% for loans greater
than $200,000. A home equity line of credit may be drawn down by the borrower
for an initial period of five years from the date of the loan agreement. During
this period, the borrower has the option of paying, on a monthly basis, either
principal and interest or only the interest. If not renewed, the borrower has to
pay back the amount outstanding under the line of credit over a term not to
exceed ten years, beginning at the end of the five year period.
- 5 -
Other consumer loans at December 31, 2002 amounted to $13.3 million, or
1.8% of Berkshire Bank's total loans and 8.4% of consumer loans. These loans
include education, collateral, personal and unsecured loans, and second mortgage
loans other than home equity lines of credit. Collateral loans are generally
secured by a passbook account, a certificate of deposit or marketable
securities. Unsecured loans generally have a maximum borrowing limitation of
$10,000 and a maximum term of five years. Second mortgages are offered on
owner-occupied primary or secondary residences and are adjustable-rate, either
adjusting annually or with a five-year initial fixed period adjusting annually
thereafter, with terms up to 30 years.
Loans secured by rapidly depreciable assets such as automobiles or that
are unsecured entail greater risks than one- to four-family mortgage loans. In
such cases, repossessed collateral for a defaulted loan may not provide an
adequate source of repayment of the outstanding loan balance, since there is a
greater likelihood of damage, loss or depreciation of the underlying collateral.
The remaining deficiency often does not warrant further substantial collection
efforts against the borrower beyond obtaining a deficiency judgment. Further,
collections on these loans are dependent on the borrower's continuing financial
stability and, therefore, are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy. Finally, the application of various
federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount which can be recovered on such loans if a borrower
defaults.
Commercial Lending
Commercial Loans. At December 31, 2002, Berkshire Bank had $165.4 million
in commercial loans which amounted to 22.9% of total loans. In addition, at such
date, Berkshire Bank had $47.9 million of unadvanced commercial lines of credit.
Berkshire Bank makes commercial business loans primarily in its market area to a
variety of professionals, sole proprietorships and small businesses. Berkshire
Bank's largest commercial loan relationship was a $5.7 million loan to a long
time customer secured by various types of business assets located in counties
adjacent to Berkshire County in New York and Connecticut. This loan was
performing according to its terms at December 31, 2002.
Berkshire Bank offers secured commercial term loans, which have maturities
of greater than one year and the repayment of which is dependent on future
earnings. The term for repayment will normally be limited to the lesser of the
expected useful life of the asset being financed or a fixed amount of time,
generally seven years or less. Berkshire Bank also offers loans originated to
finance a business' equipment and machinery, lines of credit, letters of credit,
time notes and Small Business Administration guaranteed loans. In addition,
Berkshire Bank offers revolving lines of credit called operating loans that are
secured by business assets other than real estate, such as business equipment,
inventory, and accounts receivable. Business lines of credit have adjustable
rates of interest and are payable on demand, subject to annual review and
renewal. Time notes are short-term loans, generally limited to 90 days which do
not require payment of principal or interest until maturity.
When making commercial business loans, Berkshire Bank considers the
financial statements of the borrower, the borrower's payment history of both
corporate and personal debt, the debt service capabilities of the borrower, the
projected cash flows of the business, the viability of the industry in which the
customer operates and the value of the collateral. Commercial business loans are
generally secured by a variety of collateral such as accounts receivable,
inventory and equipment, and are generally supported by personal guarantees.
Depending on the collateral used to secure the loans, commercial loans are
generally made in amounts of up to 95% of the value of the collateral securing
the loan. Berkshire Bank generally does not make unsecured commercial loans.
Unlike residential mortgage loans, which generally are made on the basis
of the borrower's ability to make repayment from his or her employment or other
income, and which are secured by real property whose value tends to be more
easily ascertainable, commercial loans are of higher risk and typically are made
on the basis of the borrower's ability to make repayment from the cash flow of
the borrower's business. As a result, the availability of funds for the
repayment of commercial loans may depend substantially on the success of the
business itself. Further, any collateral securing such loans may depreciate over
time, may be difficult to appraise and may fluctuate in value.
Loans to One Borrower. The maximum amount that Berkshire Bank may lend to
one borrower is limited by statute. At December 31, 2002, Berkshire Bank's
statutory limit on loans to one borrower was $20.8 million. At that date,
Berkshire Bank's largest amount of loans to one borrower, including the
borrower's related interests, was approximately $9.0 million and consisted of
six loans secured by various types of business and real estate assets. These
loans were performing according to their terms at December 31, 2002.
Maturity of Loan Portfolio. The following table shows the remaining
contractual maturity of Berkshire Bank's total loans at December 31, 2002,
excluding the effect of future principal prepayments.
- 6 -
At December 31, 2002
----------------------------------------------------------------------------------------------------------
One- to Construction Commercial Home
Four- and Land and Multi- Equity Lines Other
Family Development Family of Credit Automobile Consumer Commercial Total
-------- ----------- ---------- ------------ ---------- -------- ---------- --------
(In thousands)
Amounts due in:
One year or less $ 1,114 $ 13,819 $ 5,499 $ 928 $ 3,262 $ 968 $ 39,912 $ 65,502
More than one
year to five
years 6,487 2,913 14,998 9,745 88,746 9,916 28,952 161,757
More than 5 years 239,337 895 113,621 30,040 13,039 2,407 96,583 495,922
-------- -------- -------- -------- -------- -------- -------- --------
Total amount due $246,938 $ 17,627 $134,118 $ 40,713 $105,047 $ 13,291 $165,447 $723,181
======== ======== ======== ======== ======== ======== ======== ========
The following table sets forth, at December 31, 2002, the dollar amount of
loans contractually due after December 31, 2003, and whether such loans have
fixed interest rates or adjustable interest rates.
Due After December 31, 2003
--------------------------------------
Fixed Adjustable Total
-------- ---------- --------
(In thousands)
Real estate loans:
One- to four-family $113,483 $132,341 $245,824
Construction and land
development -- 3,808 3,808
Commercial and
multi-family 11,960 116,659 128,619
-------- -------- --------
Total real estate loans 125,443 252,808 378,251
Home equity lines of credit -- 39,785 39,785
Automobile 101,785 -- 101,785
Other consumer 10,360 1,963 12,323
Commercial loans 11,042 114,493 125,535
-------- -------- --------
Total loans $248,630 $409,049 $657,679
======== ======== ========
Scheduled contractual principal repayments of loans do not reflect the
actual life of the loans. The average life of a loan is substantially less than
its contractual term because of prepayments. In addition, due-on-sale clauses on
loans generally give Berkshire Bank the right to declare loans immediately due
and payable if, among other things, the borrower sells the real property with
the mortgage and the loan is not repaid. The average life of a mortgage loan
tends to increase, however, when current mortgage loan market rates are
substantially higher than rates on existing mortgage loans and, conversely,
tends to decrease when rates on existing mortgage loans are substantially higher
than current mortgage loan market rates.
Loan Approval Procedures and Authority. Berkshire Bank's lending
activities follow written, non-discriminatory, underwriting standards and loan
origination procedures established by Berkshire Bank's Board of Directors and
management. The Board of Directors has authorized the following persons and
groups of persons to approve loans up to the amounts indicated: several retail
lenders have been delegated authority to approve residential mortgage loans up
to $300,000; home equity lines of credit ranging from $50,000 to $300,000;
unsecured consumer loans from $5,000 to $30,000; and secured consumer loans from
$20,000 to $50,000. One- to four-family mortgage loans and home equity loans up
to $300,000, secured consumer loans up to $50,000 and unsecured loans up to
$30,000, may be approved by the Chairman of the Board, the President and the
Senior Vice President-Retail Lending.
One- to four- family mortgage loans and home equity loans from $300,000 to
$600,000 may be approved by a combination of individual officer authorities
provided that approval must include the signature of either the President or
Senior Vice President-Retail Lending. Approvals from $600,000 to $1.5 million
require signatures of both the President and the Senior Vice President-Retail
Lending. All residential loans in excess of $1.5 million require the approval of
the Executive Committee of the Board of Directors or the full Board of
Directors.
The Board of Directors has delegated the authority to approve loans to
several commercial loan officers in amounts ranging up to $300,000 for secured
commercial loans and in amounts ranging up to $175,000 for unsecured commercial
loans. All secured commercial loans in amounts up to $300,000 and unsecured
commercial loans in amounts up to $175,000 may be approved by the Chairman of
the Board, the President, the Senior Commercial Lender and certain commercial
loan managers. Such loans in excess of these amounts require the approval of a
majority of the members of Berkshire Bank's Senior Lending
- 7 -
Committee, which consists of the Senior Commercial Lender and all commercial
loan officers. The President, the Credit Administration Officer and the Loan
Review Officer are non-voting members of the Senior Loan Committee. Delegated
approval authorities may be combined. However, individual limits may be combined
only up to $500,000 for commercial loan approvals without requiring approval of
the Senior Lending Committee provided that commercial loans approved by a
combination of authorities must include the signature of either the President or
the Senior Commercial Lender. All commercial loans in excess of $1.5 million
require the approval of the Executive Committee of the Board of Directors or the
full Board of Directors.
Loan Originations, Purchases and Sales. Berkshire Bank's lending
activities are conducted by its salaried and commissioned loan personnel and
through its relationships with automobile dealers. Currently, Berkshire Bank has
contractual relationships with over 80 automobile dealers who originate
automobile loans for Berkshire Bank. Such loans are only made following an
underwriting review and acceptance by Berkshire Bank. These loans are closed by
the automobile dealer and immediately assigned to Berkshire Bank, who then
services the loans. On loans originated by its automobile dealers, Berkshire
Bank compensates the originator an amount by which the interest rate paid on the
loan exceeds a specified threshold, up to a maximum of four points. The
compensation is paid at the time the loan is closed and assigned to Berkshire
Bank. For the fiscal years 2002 and 2001, Berkshire Bank originated or purchased
$54.3 million and $112.6 million of automobile loans, respectively, of which
87.4% and 91.2% were originated indirectly through the automobile dealers.
From time to time, Berkshire Bank will purchase whole loans or
participations in loans. The commercial real estate loans and other commercial
loans participated in by Berkshire Bank are underwritten according to Berkshire
Bank's underwriting criteria and procedures and are generally purchased with the
accompanying servicing rights. Berkshire Bank purchased $2.7 million of such
loans in 2002. Amounts outstanding related to loan participation interests
purchased by Berkshire Bank totaled $13.7 million and $11.7 million at December
31, 2002 and December 31, 2001, respectively, and consisted primarily of loans
secured by commercial real estate.
At December 31, 2002, Berkshire Bank was servicing $19.5 million of
automobile loans, $3.7 million of one- to four-family mortgage loans and $5.4
million of commercial loans sold to others. Loan servicing includes collecting
and remitting loan payments, accounting for principal and interest, contacting
delinquent borrowers, supervising foreclosures and property dispositions when
there are unremedied defaults, making insurance and tax payments on behalf of
the borrowers and generally administering the loans. The gross servicing fee
income from loans sold is generally 25 basis points for one- to four-family
mortgage loans and 100 basis points for automobile loans of the total balance of
the loan being serviced.
Berkshire Bank generally originates loans for its own portfolio but from
time to time will sell loans in the secondary market based on prevailing market
interest rate conditions and an analysis of the composition and risk of the loan
portfolio and liquidity needs. In 2001, Berkshire Bank established a program
with an outside third party lender whereby Berkshire Bank originated fixed rate
one- to four- family mortgages for sale. Fixed rate residential loans of $3.1
million were originated and sold to this third party early in 2002 before
discontinuing the program. In addition, Berkshire Bank sold $69.7 million of
sub-prime automobile loans in 2002.
- 8 -
The following table presents total loans originated, purchased, sold and
repaid during the periods indicated.
For the Years Ended December 31,
----------------------------------
2002 2001 2000
--------- --------- ---------
(In thousands)
Loans at beginning of year $ 802,985 $ 793,389 $ 673,918
--------- --------- ---------
Originations:
Real estate loans:
One-to four-family 88,770 36,668 31,231
Construction and land development 30,678 22,170 25,071
Commercial 37,564 13,296 2,289
Multi-family 5,242 800 7,671
--------- --------- ---------
Total real estate loans 162,254 72,934 66,262
--------- --------- ---------
Consumer loans:
Home equity lines of credit 16,361 6,887 8,225
Automobile 54,284 105,124 128,327
Other 4,613 4,527 16,799
--------- --------- ---------
Total consumer loans 75,258 116,538 153,351
Commercial loans 48,343 63,456 64,887
--------- --------- ---------
Total loans originated 285,855 252,928 284,500
--------- --------- ---------
Purchases:
Real estate loans:
Commercial real estate 2,724 4,042 4,664
--------- --------- ---------
Total real estate loans 2,724 4,042 4,664
Consumer loans:
Automobile -- 7,451 48,724
Commercial loans -- 2,000 3,175
--------- --------- ---------
Total loans purchased 2,724 13,493 56,563
--------- --------- ---------
Deduct:
Principal loan repayments, repayments
and other, net 285,852 226,179 181,082
Loan sales 73,625 24,263 38,942
Net loan charge-offs 6,906 6,357 1,488
Transfers to real estate owned 2,000 26 80
--------- --------- ---------
Total deductions 368,383 256,825 221,592
--------- --------- ---------
Net increase (decrease) in loans (79,804) 9,596 119,471
--------- --------- ---------
Loans at end of year $ 723,181 $ 802,985 $ 793,389
========= ========= =========
Loan Commitments. Berkshire Bank issues loan commitments to its
prospective borrowers conditioned on the occurrence of certain events.
Commitments are made in writing on specified terms and conditions and are
generally honored for up to 60 days from approval. At December 31, 2002,
Berkshire Bank had loan commitments and unadvanced loans and lines of credit
totaling $142.4 million.
Loan Fees. In addition to interest earned on loans, Berkshire Bank
receives income from fees derived from loan originations, loan modifications,
late payments and for miscellaneous services related to its loans. Income from
these activities varies from period to period depending upon the volume and type
of loans made and competitive conditions.
Berkshire Bank charges loan origination fees which are calculated as a
percentage of the amount borrowed. As required by applicable accounting
principles, loan origination fees, discount points and certain loan origination
costs are deferred and recognized over the contractual remaining lives of the
related loans on a level yield basis. At December 31, 2002, Berkshire Bank
- 9 -
had approximately $41,000 of net deferred loan fees and costs. Berkshire Bank
amortized approximately $33,000 of net deferred loan fees and costs during the
year ended December 31, 2002.
Nonperforming Assets, Delinquencies and Impaired Loans. When a borrower
fails to make a required loan payment, Berkshire Bank attempts to cure the
deficiency by mailing a past due notice on the 10th day after payment is due. In
most cases, delinquencies are cured promptly. If a delinquency continues beyond
the 15th day after the payment is due, the loan will appear on a delinquency
list and the account officer will contact the borrower. If a delinquency
continues beyond the 30th day, the borrower is again contacted and if it is
determined that the late payment is not a short-term cash flow problem, the
account is reported to the Senior Loan Officer. While Berkshire Bank generally
prefers to work with borrowers to resolve problems, Berkshire Bank generally
will initiate foreclosure or other proceedings no later than the 90th day of a
delinquency, as necessary, to minimize any potential loss.
Management informs the Board of Directors monthly of the amount of loans
delinquent more than 30 days, all loans in foreclosure, and all foreclosed and
repossessed property that Berkshire Bank owns. Berkshire Bank generally ceases
accruing interest on all commercial and residential loans when principal or
interest payments are delinquent 90 days or more unless management determines
the loan principal and interest to be fully-secured and in the process of
collection. Once management determines that interest is uncollectible, the
accrual of interest income on a loan is discontinued and all interest previously
accrued is reversed against current period interest income. In 2001, as a
measure to enhance its risk management practices, the Bank initiated a more
conservative policy for automobile loans whereby all delinquent automobile loans
remain on accrual status until they reach 120 days delinquent at which time they
are charged-off, except for those customers who are in bankruptcy proceedings
with a secured loan, in which case the loan is transferred to nonaccrual status.
Berkshire Bank has adopted Statements of Financial Accounting Standards
("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan," as amended
by SFAS No. 118 "Accounting by Creditors for Impairment of a Loan--an amendment
to SFAS No. 114." At December 31, 2002 and December 31, 2001, Berkshire Bank had
$727,000 and $778,000, respectively, recorded investment in impaired loans,
which had no specific allowances and $2.1 million and $1.4 million in loans with
specific valuation allowances of $295,000 and $113,000, respectively.
The following table sets forth information regarding nonperforming assets
and loans that were 90 days or more past due and still accruing at the dates
indicated.
At December 31,
----------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
(Dollars in thousands)
Nonaccruing loans:
One- to four-family real estate $ 230 $ 310 $ 390 $ 450 $1,272
Commercial real estate -- -- -- -- 1,064
Commercial 2,850 2,077 466 1,572 612
Consumer(1) 661 315 2,013 819 542
------ ------ ------ ------ ------
Total nonperforming loans 3,741 2,702 2,869 2,841 3,490
Real estate owned 1,500 -- 50 220 398
------ ------ ------ ------ ------
Total nonperforming assets $5,241 $2,702 $2,919 $3,061 $3,888
====== ====== ====== ====== ======
Total nonperforming loans as a
percentage of total loans 0.52% 0.34% 0.36% 0.42% 0.58%
Total nonperforming assets as a
percentage of total assets 0.50% 0.26% 0.29% 0.36% 0.50%
Loans 90 days or more past due
and still accruing(2) $ 590 $1,306 $ -- $ -- $ --
- ----------
(1) Consists primarily of automobile loans.
(2) Reflects Bank's policy on delinquent automobile loans whereby all
delinquent automobile loans remain on accrual status until they reach 120
days delinquent, at which time they are charged off. Previous to 2001,
automobile loans past due 90 days or more were reported as nonaccrual.
Nonaccruing commercial loans increased to $2.9 million at December 31,
2002 from $2.1 million at December 31, 2001 primarily as the result of one $1.8
million commercial relationship which, although still performing within its
terms at December 31, 2002, was determined by Bank management to be impaired
based on the business' financial results and collateral protection. The
companies with loans in Berkshire Bank's nonaccruing commercial loan portfolio
have been adversely affected by national and regional economic conditions.
- 10 -
Interest income that would have been recorded for the year ended December
31, 2002, had nonaccruing loans been current according to their original terms,
amounted to $188,000. A total of $85,000 was included in interest income to
reflect payments received on loans that had been paid off or brought up to date
but were still classified as nonaccruing.
The following tables set forth the delinquencies in Berkshire Bank's loan
portfolio as of the dates indicated.
At December 31, 2002 At December 31, 2001
----------------------------------------------------- ----------------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
----------------------- ----------------------- ----------------------- -----------------------
Principal Principal Principal Principal
Number Balance Number Balance Number Balance Number Balance
of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans
-------- -------- -------- -------- -------- -------- -------- --------
Dollars in thousands
Real estate loans:
One- to four-
family 3 $ 207 4 $ 92 3 $ 144 3 $ 254
Commercial -- -- -- -- -- -- -- --
Multi-family -- -- -- -- -- -- -- --
Consumer loans:
Home equity lines
of credit -- -- -- -- -- -- -- --
All other(1) 120 924 118 893 323 2,645 217 1,621
Commercial loans: 2 49 4 110 2 381 7 1,234
------ ------ ------ ------ ------ ------ ------ ------
Total 125 $1,180 126 $1,095 328 $3,170 227 $3,109
====== ====== ====== ====== ====== ====== ====== ======
Delinquent loans to
total loans 0.57% 0.16% 0.57% 0.15% 0.96% 0.39% 0.66% 0.39%
At December 31, 2000
-----------------------------------------------------
60-89 Days 90 Days or More
----------------------- -----------------------
Principal Principal
Number Balance Number Balance
of Loans of Loans of Loans of Loans
-------- -------- -------- --------
Dollars in thousands
Real estate loans:
One- to four-
family 2 $ 154 2 $ 43
Commercial -- -- -- --
Multi-family -- -- -- --
Consumer loans:
Home equity lines
of credit 2 57 1 20
All other(1) 238 1,728 262 1,923
Commercial loans: 4 129 3 149
------ ------ ------ ------
Total 246 $2,068 268 $2,135
====== ====== ====== ======
Delinquent loans to
total loans 0.73% 0.26% 0.79% 0.27%
- ----------
(1) Consists primarily of automobile loans.
Real Estate Owned. Real estate acquired by Berkshire Bank as a result of
foreclosure or by deed in lieu of foreclosure is classified as real estate owned
until sold. When property is acquired it is recorded at fair market value at the
date of foreclosure, establishing a new cost basis. Holding costs and declines
in fair value after acquisition are expensed. At December 31, 2002, Berkshire
Bank had one foreclosed commercial property valued at $1.5 million. On February
13, 2003, the Bank sold this property for $1.5 million.
Asset Classification. Regulators have adopted various regulations and
practices regarding problem assets of savings institutions. Under such
regulations, federal and state examiners have authority to identify problem
assets during examinations and, if appropriate, require them to be classified.
Berkshire Bank performs an internal analysis of its loan portfolio and assets to
classify such loans and assets similar to the manner in which such loans and
assets are classified by the federal banking regulators. In addition, Berkshire
Bank regularly analyzes the losses inherent in its loan portfolio and its
nonperforming loans to determine the appropriate level of the allowance for loan
losses.
There are three classifications for problem assets: substandard, doubtful
and loss. Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified as loss is considered uncollectible and
of such little value that continuance as an asset of the institution is not
warranted. If an asset or portion thereof is classified as loss, the insured
institution establishes specific allowances for loan losses for the full amount
of the portion of the asset classified as loss. All or a portion of general loan
loss allowances established to cover probable losses related to assets
classified as substandard or doubtful can be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses generally do not qualify as regulatory capital. Assets that do not
currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses
are designated "special mention."
- 11 -
The following table sets forth Berkshire Bank's classified assets at
December 31, 2002.
Loss Doubtful Substandard Special Mention
---------------------- ---------------------- ---------------------- ----------------------
Number Principal Number Principal Number Principal Number Principal
of Loans Balance of Loans Balance of Loans Balance of Loans Balance
-------- ------- -------- ------- -------- ------- -------- -------
(Dollars in thousands)
Real estate loans:
One- to four-family -- $ -- -- $ -- 9 $ 366 3 $ 207
Commercial -- -- -- -- 1 203 5 5,081
Multi-family -- -- -- -- 1 219 -- --
Construction and land
development -- -- -- -- -- -- 1 4,106
Consumer loans:
Home equity lines of
credit -- -- -- -- -- -- -- --
Automobile -- -- -- -- 146 1,355 115 890
All other -- -- -- -- 10 30 5 34
Commercial loans -- -- -- -- 47 4,657 44 9,022
------- ------- ------- ------- ------- ------- ------- -------
Total -- $ -- -- $ -- 214 $ 6,830 173 $19,340
======= ======= ======= ======= ======= ======= ======= =======
At December 31, 2002, Berkshire Bank had four outstanding commercial loans
with one borrower, which were adversely classified or identified as a problem
credit, totaling $1.8 million. Although still performing, these loans were
classified as substandard and were secured by a lien on the borrower's accounts
receivable, inventory and other commercial business assets. Based on
management's collateral value estimates, $481,000 of Berkshire Bank's December
31, 2002 allowance for loan losses have been allocated to this borrowing
relationship. Management believes that the current allocation is adequate.
Berkshire Bank had no other classified loans greater than $500,000 which were
not performing according to their terms on December 31, 2002.
Allowance for Loan Losses. In originating loans, Berkshire Bank recognizes
that losses will be experienced on loans and that the risk of loss will vary
with, among other things, the type of loan being made, the creditworthiness of
the borrower over the term of the loan, general economic conditions and, in the
case of a secured loan, the quality of the security for the loan. Berkshire Bank
maintains an allowance for loan losses to absorb losses inherent in the loan
portfolio. The allowance for loan losses represents management's estimate of
probable losses based on information available as of the date of the financial
statements. The allowance for loan losses is based on management's evaluation of
the collectibility of the loan portfolio, including past loan loss experience,
known and inherent risks in the nature and volume of the portfolio, information
about specific borrower situations and estimated collateral values and economic
conditions.
The loan portfolio and other credit exposures are regularly reviewed by
management to evaluate the adequacy of the allowance for loan losses. The
methodology for assessing the appropriateness of the allowance includes
comparison to actual losses, peer group comparisons, industry data and economic
conditions. In addition, management employs an independent third party to
perform a review of all of Berkshire Bank's commercial loan relationships
exceeding $1.0 million, all material credits on Berkshire Bank's watch list or
classified as Substandard and a random sampling of new loans. The regulatory
agencies, as an integral part of their examination process, also periodically
review Berkshire Bank's allowance for loan losses. Such agencies may require
Berkshire Bank to make additional provisions for estimated losses based upon
judgments different from those of management.
In assessing the allowance for loan losses, loss factors are applied to
various pools of outstanding loans and certain unused commitments. Berkshire
Bank segregates the loan portfolio according to risk characteristics (i.e.,
mortgage loans, home equity, consumer, commercial). Loss factors are derived
using Berkshire Bank's historical loss experience and may be adjusted for
significant factors that, in management's judgment, affect the collectibility of
the portfolio as of the evaluation date.
All classified loans are reviewed for adequacy of their estimated
supporting collateral values and guarantees. If a loan is determined to have a
recovery value less than the loan balance after deducting the general reserve
assigned to that loan based upon its classification, an additional specific
reserve is assigned in an amount equal to the projected shortfall.
In addition, management assesses the allowance using factors that cannot
be associated with specific credit or loan categories. These factors include
management's subjective evaluation of local and national economic and business
conditions, portfolio concentration and changes in the character and size of the
loan portfolio. The allowance methodology reflects management's objective that
the overall allowance appropriately reflects a margin for the imprecision
necessarily inherent in estimates of expected credit losses.
- 12 -
Although management believes that it uses the best information available
to establish the allowance for loan losses, future adjustments to the allowance
for loan losses may be necessary and results of operations could be adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations. Furthermore, while Berkshire Bank believes it has
established its existing allowance for loan losses in conformity with accounting
principles generally accepted in the United States of America, there can be no
assurance that regulators, in reviewing Berkshire Bank's loan portfolio, will
not request Berkshire Bank to increase its allowance for loan losses. In
addition, because future events affecting borrowers and collateral cannot be
predicted with certainty, there can be no assurance that the existing allowance
for loan losses is adequate or that increases will not be necessary should the
quality of any loans deteriorate as a result of the factors discussed above. Any
material increase in the allowance for loan losses may adversely affect
Berkshire Bank's financial condition and results of operations.
The following table presents an analysis of Berkshire Bank's allowance for
loan losses for the years indicated.
At or For the Years Ended December 31,
---------------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------- ------- -------
(Dollars in thousands)
Allowance for loan losses,
beginning of year $11,034 $10,216 $ 8,534 $ 7,589 $ 6,078
------- ------- ------- ------- -------
Charged-off loans:
One- to four-family real estate -- 2 -- 117 14
Multi-family -- 222 -- -- --
Commercial real estate 510 -- 19 297 253
Consumer(1) 9,074 5,989 1,422 731 311
Home equity lines of credit -- 52 -- -- --
Commercial 444 797 469 1,208 234
------- ------- ------- ------- -------
Total charged-off loans 10,028 7,062 1,910 2,353 812
Recoveries on loans previously
charged off 3,122 705 422 268 268
------- ------- ------- ------- -------
Net loans charged off 6,906 6,357 1,488 2,085 544
Provision for loan losses 6,180 7,175 3,170 3,030 2,055
------- ------- ------- ------- -------
Allowance for loan losses, end of year $10,308 $11,034 $10,216 $ 8,534 $ 7,589
======= ======= ======= ======= =======
Ratios:
Net loans charged off to
interest-earning loans 0.96% 0.79% 0.19% 0.31% 0.09%
Allowance for loan losses to total loans 1.43% 1.37% 1.29% 1.27% 1.25%
Allowance for loan losses to
nonperforming loans 275.54% 408.36% 356.08% 300.39% 217.45%
Net loans charged off to allowance
for loan losses 67.00% 57.61% 14.57% 24.43% 7.17%
Recoveries to charged-off loans 31.13% 9.98% 22.09% 11.39% 33.00%
- ----------
(1) Consists primarily of automobile loans.
- 13 -
The following table presents the approximate allocation of the allowance for
loan losses by loan categories at the dates indicated and the percentage of such
amounts to the total allowance and to total loans. Management believes that the
allowance can be allocated by category only on an approximate basis. The
allocation of the allowance to each category is not indicative of future losses
and does not restrict the use of any of the allowance to absorb losses in any
category.
At December 31,
-------------------------------------------------------------------------------------------------------------
2002 2001 2000
---------------------------------- ---------------------------------- ----------------------------------
Percent of Percent of Percent of Percent of Percent of Percent of
Allowance Allowance Allowance Allowance Allowance Allowance
in Each in Each in Each in Each in Each in Each
Category Category Category Category Category Category
to Total to Total to Total to Total to Total to Total
Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans
------- ------- ------- ------- ------- ------- ------- ------- -------
(Dollars in thousands)
Real estate loans $ 2,289 22.21% 55.14% $ 2,347 21.27% 45.05% $ 2,337 22.88% 43.27%
Consumer loans 4,650 45.11 22.00 4,217 38.22 33.75 4,528 44.32 35.69
Commercial loans 3,369 32.68 22.86 4,470 40.51 21.20 3,351 32.80 21.04
------- ------- ------- ------- ------- ------- ------- ------- -------
Total allowance for
loan losses $10,308 100.00% 100.00% $11,034 100.00% 100.00% $10,216 100.00% 100.00%
======= ======= ======= ======= ======= ======= ======= ======= =======
At December 31,
------------------------------------------------------------------------
1999 1998
---------------------------------- ----------------------------------
Percent of Percent of Percent of Percent of
Allowance Allowance Allowance Allowance
in Each in Each in Each in Each
Category Category Category Category
to Total to Total to Total to Total
Amount Allowance Loans Amount Allowance Loans
------- ------- ------- ------- ------- -------
(Dollars in thousands)
Real estate loans $ 2,322 27.20% 47.34% $ 2,262 29.81% 49.51%
Consumer loans 2,867 33.60 30.97 2,339 30.82 28.38
Commercial loans 3,345 39.20 21.69 2,988 39.37 22.11
------- ------- ------- ------- ------- -------
Total allowance for
loan losses $ 8,534 100.00% 100.00% $ 7,589 100.00% 100.00%
======= ======= ======= ======= ======= =======
Investment Securities Activities
General. Under Massachusetts law, Berkshire Bank has authority to purchase
a wide range of investment securities. As a result of changes in federal banking
laws, however, financial institutions such as Berkshire Bank may not engage as
principals in any activities that are not permissible for a national bank,
unless the Federal Deposit Insurance Corporation has determined that the
investments would pose no significant risk to the Bank Insurance Fund and
Berkshire Bank is in compliance with applicable capital standards. In 1993, the
Regional Director of the Federal Deposit Insurance Corporation approved a
request by Berkshire Bank to acquire and retain certain listed stocks and/or
registered stocks subject to certain conditions. The Company makes its
investments through Berkshire Bank or one of the Bank's securities corporation
subsidiaries and is generally not subject to any such restrictions on its
investment authority. (See "Regulation and Supervision").
Berkshire Bank's main source of income has been and will continue to be
derived from its loan portfolio. The investment securities portfolio is
primarily used to provide for Berkshire Bank's cash flow needs, to provide
adequate liquidity to protect the safety of customer deposits and to earn a
reasonable return on investment. The structure of the investment securities
portfolio is based upon the composition and quality of the loan portfolio and
Berkshire Bank's liquidity position and deposit structure.
Berkshire Bank's investment policy divides investments into two
categories, fixed income and equity portfolios. The primary objectives of the
fixed income portfolio are to: (1) maintain an adequate source of liquidity
sufficient to meet regulatory and operating requirements, including funding for
loans; (2) safeguard against deposit outflows, reduced loan amortization and
increased loan demand; and (3) manage interest rate risk. The fixed income
securities portfolio primarily consists of debt issues, including corporate and
municipal bonds, U.S. Government and Agency obligations and mortgage-backed and
asset-backed securities, including collateralized mortgage obligations and real
estate mortgage investment conduits. A collateralized mortgage obligation is a
mortgage-backed bond that separates mortgage pools into different maturities
called "tranches." Tranches pay different rates of interest and can mature in a
few months, or a few years. In return for a lower yield, collateralized mortgage
obligations provide increased security over the life of the investment. However,
in a lowering interest rate risk environment,
- 14 -
collateralized mortgage obligations tend to be repaid before their expected
maturities as prepayments increase. This may result in Berkshire Bank having to
reinvest the funds at a lower interest rate. Real estate mortgage investment
conduits, a type of collateralized mortgage obligation, are similar in that
securities representing an undivided interest in such mortgages are issued.
However, real estate mortgage investment conduits have more flexibility than
other types of collateralized mortgage obligations as issuers can separate
mortgage pools not only into different maturity classes but also into different
risk classes. At present, 78.9% of Berkshire Bank's mortgage-backed securities
are issued or guaranteed by agencies of the U.S. Government, which carry lower
credit risk than mortgage-backed securities of a private issuer. Other types of
asset-backed securities in which Berkshire Bank invests are typically
collateralized by the cash flow from a pool of automobile loans, credit card
receivables, consumer loans and other similar obligations. Both mortgage-backed
and asset-backed securities carry the risk that changing market interest rates
may cause a change in market value.
The marketable equity securities portfolio is currently managed to produce
capital gains through price appreciation and lowering taxable income through
deductions permitted for a portion of dividends received. The marketable equity
securities portfolio consists primarily of bank, utility and industrial stocks
and is currently limited by the investment policy to 100% of Tier I capital.
Berkshire Bank had $91.1 million of Tier 1 Capital at December 31, 2002. In the
fourth quarter of 2002, Berkshire Bank restructured its investment portfolio by
placing less emphasis on equity securities. Equities totaling $18.8 million were
sold resulting in a gain of $14.8 million. At December 31, 2002, equities,
excluding Federal Home Loan Bank and Savings Bank Life Insurance stock,
comprised 9.0% of the investment portfolio compared to 28.4% at December 31,
2001. The gross unrealized gains associated with the marketable equity
securities portfolio were $8.5 million and the gross unrealized losses were
$77,000. The marketable equity securities portfolio carries equity price risk in
that, if equity prices decline due to unfavorable market conditions or other
factors, Berkshire Bank's capital would decrease.
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," requires that securities be categorized as "held to maturity,"
"trading securities" or "available for sale," based on management's intent as to
the ultimate disposition of each security. SFAS No. 115 allows debt securities
to be classified as "held to maturity" and reported in financial statements at
amortized cost only if the reporting entity has the positive intent and ability
to hold those securities to maturity. Securities that might be sold in response
to changes in market interest rates, changes in the security's prepayment risk,
increases in loan demand, or other similar factors cannot be classified as "held
to maturity." Debt and equity securities held for current resale are classified
as "trading securities." These securities are reported at fair value, and
unrealized gains and losses on the securities would be included in earnings.
Berkshire Bank does not currently use or maintain a trading account. Debt and
equity securities not classified as either "held to maturity" or "trading
securities" are classified as "available for sale." These securities are
reported at fair value, and unrealized gains and losses on the securities are
excluded from earnings and included in accumulated other comprehensive income,
net of taxes.
The Executive Committee of the Board of Directors is responsible for
developing and reviewing Berkshire Bank's investment policy. Investment
decisions are made in accordance with Berkshire Bank's investment policy and are
based upon the quality of a particular investment, its inherent risks, Berkshire
Bank's liquidity needs, prospects for yield and/or appreciation and the
potential tax consequences. While general investment strategies are developed
and authorized by the Executive Committee, the execution of specific investment
actions and the day-to-day oversight of Berkshire Bank's investment portfolio
rests with the Chairman, President and Treasurer. These officers are authorized
to execute investment transactions up to specified limits based on the type of
security without the prior approval of the Executive Committee. However, such
purchases require the ratification of the Executive Committee at their next
scheduled meeting. The Board of Directors receives a monthly report of all
securities transactions made during the previous month.
Berkshire Bank's investment policy allows the use of certain hedging
strategies, including the purchase of options in an effort to increase the
return and decrease the risk on the securities portfolio. Berkshire Bank has
used covered call option strategies in the past and will continue to do so in
the future. Berkshire Bank has not used interest rate futures or options on
futures as part of its interest rate hedging strategies.
- 15 -
The following table presents the amortized cost and fair value of
Berkshire Bank's available for sale securities, by type of security, at the
dates indicated.
At December 31,
------------------------------------------------------------------------------------
2002 2001 2000
------------------------ ------------------------ ------------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- -------- --------- -------- --------- --------
(In thousands)
Investment securities:
Obligations of U.S. Treasury and
U.S. Government Agencies $ 98,058 $ 98,719 $ 13,876 $ 14,017 $ 10,146 $ 10,106
Corporate bonds and notes 31,284 31,637 31,017 31,251 31,750 31,034
Asset-backed securities 6,956 6,772 1,484 1,496 1,986 1,998
Marketable equity securities(1) 11,132 19,581 11,447 39,803 12,022 43,060
-------- -------- -------- -------- -------- --------
Total investment securities 147,430 156,709 57,824 86,567 55,904 86,198
-------- -------- -------- -------- -------- --------
Mortgage-backed securities:
Freddie Mac 3,558 3,605 3,292 3,335 2,203 2,257
Fannie Mae 3,066 3,051 2,774 2,845 2,619 2,670
Private label REMICs 9,761 9,750 11,555 11,619 8,022 8,049
Ginnie Mae 52 54 78 80 133 135
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities 16,437 16,460 17,699 17,879 12,977 13,111
-------- -------- -------- -------- -------- --------
Total available for sale securities $163,867 $173,169 $ 75,523 $104,446 $ 68,881 $ 99,309
======== ======== ======== ======== ======== ========
- ----------
(1) Includes mutual funds.
The following table presents the amortized cost and fair value of
Berkshire Bank's held for maturity securities, by type of security, at the dates
indicated.
At December 31,
------------------------------------------------------------------------------------
2002 2001 2000
------------------------ ------------------------ ------------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- -------- --------- -------- --------- --------
(In thousands)
Investment securities:
Municipal notes and other
obligations $ 14,480 $ 14,480 $ 11,241 $ 11,241 $ 10,825 $ 10,825
-------- -------- -------- -------- -------- --------
Total investment securities 14,480 14,480 11,241 11,241 10,825 10,825
-------- -------- -------- -------- -------- --------
Mortgage-backed securities:
Freddie Mac 17,120 17,164 9,790 9,851 10,686 10,726
Fannie Mae 11,657 11,688 11,177 11,253 10,466 10,533
Ginnie Mae 1,010 1,016 1,055 1,064 261 258
-------- -------- -------- -------- -------- --------
Total mortgage-backed 29,787 29,868 22,022 22,168 21,413 21,517
securities -------- -------- -------- -------- -------- --------
Total held to maturity securities $ 44,267 $ 44,348 $ 33,263 $ 33,409 $ 32,238 $ 32,342
======== ======== ======== ======== ======== ========
At December 31, 2002, Berkshire Bank did not own any investment or
mortgage-backed securities of a single issuer, other than U.S. Treasury and U.S.
Government Agency securities, which had an aggregate book value in excess of 10%
of Berkshire Bank's capital at that date.
- 16 -
The following presents the activity in the investment securities and
mortgage-backed securities portfolios for the years indicated.
For the Years Ended December 31,
-------------------------------------------
2002 2001 2000
--------- --------- ---------
(In thousands)
Investment securities:
Investment securities, beginning of year $ 97,808 $ 97,023 $ 89,671
--------- --------- ---------
Purchases 195,005 49,212 91,904
Sales (13,112) (3,697) (32,431)
Loss on impairment of securities (673) -- --
Maturities and calls (84,606) (39,559) (52,314)
Repayments and prepayments (3,191) (2,395) (2,537)
Net (premium) (578) (1,225) (483)
Increase/(decrease) in unrealized gain (19,464) (1,551) 3,213
--------- --------- ---------
Net increase in investment securities 73,381 785 7,352
--------- --------- ---------
Investment securities, end of year 171,189 97,808 97,023
--------- --------- ---------
Mortgage-backed securities:
Mortgage-backed securities, beginning of year 39,901 34,524 20,427
--------- --------- ---------
Purchases 63,065 43,853 32,707
Repayments and prepayments (56,037) (39,477) (18,794)
Net (premium) discount (525) 955 52
Increase /(decrease) in unrealized gain (157) 46 132
--------- --------- ---------
Net increase in mortgage-backed securities 6,346 5,377 14,097
--------- --------- ---------
Mortgage-backed securities, end of year 46,247 39,901 34,524
--------- --------- ---------
Total securities, end of year $ 217,436 $ 137,709 $ 131,547
========= ========= =========
The following table presents certain information regarding the amortized
cost, weighted average yields and estimated maturities or periods to repricing
of Berkshire Bank's debt securities at December 31, 2002.
At December 31, 2002
------------------------------------------------------------------
More than One Year More than Five Years
One Year or Less to Five Years to Ten Years
------------------- ------------------- --------------------
Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
Investment securities:
Obligations of U.S. Treasury and
U.S. Government Agencies $ 88,662 2.57% $ 9,396 3.49% $ -- - %
Mortgage-backed securities 26,020 0.66 20,204 4.02 -- --
Municipal notes 6,511 1.80 4,420 4.38 2,165 4.85
Corporate bonds and notes 11,934 3.56 15,160 3.97 63 31.20
Asset-backed securities 4,006 2.33 2,261 6.13 255 0.80
-------- -------- --------
Total $137,133 2.25% $ 51,441 4.03% $ 2,483 5.10%
======== ======== ========
At December 31, 2002
------------------------------------------
More than Ten Years Total
-------------------- -------------------
Weighted Weighted
Amortized Average Amortized Average
Cost Yield Cost Yield
-------- --------- -------- --------
(Dollars in thousands)
Investment securities:
Obligations of U.S. Treasury and
U.S. Government Agencies $ -- - % $ 98,058 2.66%
Mortgage-backed securities -- -- 46,224 2.13
Municipal notes 3,489 5.90 16,585 3.75
Corporate bonds and notes 2,022 7.01 29,179 4.07
Asset-backed securities 434 2.69 6,956 3.53
-------- --------
Total $ 5,945 6.04% $197,002 2.86%
======== ========
Deposit Activities and Other Sources of Funds
General. Deposits are the major source of funds for Berkshire Bank's
lending and other investment activities. In addition, Berkshire Bank also
generates funds internally from loan repayments and prepayments and maturing
investment securities. Scheduled loan repayments are a relatively stable source
of funds, while deposit inflows and outflows and loan prepayments are influenced
significantly by general interest rates and money market conditions. Berkshire
Bank uses borrowings
- 17 -
from the Federal Home Loan Bank of Boston as an additional source of funding for
loan and securities investment activity. To a lesser extent, Berkshire Bank also
utilizes retail repurchase agreements as a source of funds.
Deposit Accounts. Substantially all of Berkshire Bank's deposits are
generated from the areas surrounding its branch offices. Berkshire Bank offers a
wide variety of deposit accounts with a range of interest rates and terms.
Berkshire Bank's deposit accounts consist of interest-bearing checking,
noninterest-bearing checking, regular savings, money market savings and
certificates of deposit. The initial maturities of Berkshire Bank's certificate
of deposit accounts range from three months to ten years. In addition, Berkshire
Bank offers retirement accounts, including Traditional IRAs, Roth IRAs, Simple
IRAs, Self-Directed IRAs and Keogh accounts, simplified employee pension plan,
profit-sharing qualified plan and money purchase pension plan accounts.
Berkshire Bank also offers a variety of deposit accounts designed for the
businesses operating in its market area. Deposit account terms vary with the
principal differences being the minimum balance deposit, early withdrawal
penalties, limits on the number of transactions and the interest rate. Berkshire
Bank's business banking deposit products include a commercial checking account
which provides an earnings credit to offset monthly service charges and a
checking account specifically designed for small businesses. Additionally,
Berkshire Bank offers sweep accounts and money market accounts for businesses
and IOLTA interest checking and escrow accounts. Berkshire Bank has sought to
increase its commercial deposits through the offering of these products,
particularly to its commercial borrowers and to the municipalities that
participate in its government banking program.
Berkshire Bank reviews its deposit mix and pricing on a weekly basis and
believes it offers competitive interest rates on its deposit products. Berkshire
Bank determines the rates paid based on a number of factors, including rates
paid by competitors, Berkshire Bank's need for funds and cost of funds,
Berkshire Bank's current asset/liability structure, the amount of maturing
deposits and movements of market interest rates. Berkshire Bank currently does
not utilize brokers to obtain deposits but may choose to do so in the future.
In the unlikely event Berkshire Bank is liquidated, depositors will be
entitled to full payment of their deposit accounts before any payment is made to
Berkshire Hills as the sole stockholder of Berkshire Bank.
The following table presents the deposit activity of Berkshire Bank for
the years indicated.
For the Years Ended December 31,
-------------------------------
2002 2001 2000
-------- -------- --------
(In thousands)
Increase/(decrease) before interest credited $ 21,854 $(13,550) $ 21,224
Interest credited 17,777 26,685 27,603
-------- -------- --------
Net increase $ 39,631 $ 13,135 $ 48,827
======== ======== ========
At December 31, 2002, Berkshire Bank had certificate of deposit accounts
in amounts of $100,000 or more maturing as follows:
Weighted
Average
Maturity Period Amount Rate
- -----------------------------------------------------------------------
(Dollars in thousands)
Three months or less $ 34,599 3.18%
Over 3 months through 6 months 30,420 3.08
Over 6 months through 12 months 16,286 3.46
Over 12 months 54,249 4.80
--------
Total $135,554 3.84%
========
- 18 -
The following table presents information concerning average balances and
weighted average interest rates on Berkshire Bank's deposit accounts for the
years indicated.
For the Years Ended December 31,
-----------------------------------------------------------------------------------------------------
2002 2001 2000
------------------------------- ------------------------------- -------------------------------
Percent of Percent of Percent of
Total Weighted Total Weighted Total Weighted
Average Average Average Average Average Average Average Average Average
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
-------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Money market accounts $117,950 15.48% 1.69% $112,434 15.31% 3.30% $106,058 15.09% 4.43%
NOW accounts 83,399 10.95 0.75 77,276 10.52 1.04 75,673 10.76 1.05
Savings(1) 157,444 20.66 1.70 142,150 19.36 2.88 143,357 20.39 3.19
Certificates of deposit 320,418 42.05 3.91 325,639 44.34 5.55 301,920 42.94 5.81
Demand accounts 82,752 10.86 -- 76,912 10.47 -- 76,060 10.82 --
-------- -------- -------- -------- -------- -------
Total $761,963 100.00% 2.33% $734,411 100.00% 3.63% $703,068 100.00% 3.93%
======== ======== ======== ======== ======== =======
- ----------
(1) Includes mortgagors' escrow accounts.
Certificates of Deposit by Rates and Maturities. The following table
presents the amount of certificate accounts categorized by rates and maturities,
for the periods and years indicated.
Period to Maturity from December 31, 2002
---------------------------------------------- Total at December 31,
Less than One to Two to Over ------------------------------
One Year Two Years Three Years Three Years 2002 2001 2000
--------- --------- ----------- ----------- -------- -------- --------
(In thousands)
0.00-4.00% $185,183 $ 47,157 $ 4,405 $ 84 $236,829 $107,984 $ 5
4.01-5.00% 13,086 2,633 12,675 14,625 43,019 79,635 3,973
5.01-6.00% 3,635 3,901 1,315 11,345 20,196 50,726 101,693
6.01-7.00% 13,282 2,540 2,787 9,814 28,423 70,223 205,586
7.01% and above 13 86 1,623 -- 1,722 8,669 8,516
-------- -------- -------- -------- -------- -------- --------
Total $215,199 $ 56,317 $ 22,805 $ 35,868 $330,189 $317,237 $319,773
======== ======== ======== ======== ======== ======== ========
Borrowings. Berkshire Bank utilizes advances from the Federal Home Loan
Bank of Boston to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. The Federal Home Loan Bank of Boston functions as a
central reserve bank providing credit for savings banks and certain other member
financial institutions. As a member of the Federal Home Loan Bank of Boston,
Berkshire Bank is required to own capital stock in the Federal Home Loan Bank of
Boston and may apply for advances on the security of the capital stock and
certain of its mortgage loans and other assets, principally securities that are
obligations of, or guaranteed by, the U.S. Government or its Agencies, provided
certain creditworthiness standards have been met. Advances are made under
several different credit programs. Each credit program has its own interest rate
and range of maturities. Depending on the program, limitations on the amount of
advances are based on the financial condition of the member institution and the
adequacy of collateral pledged to secure the credit. At December 31, 2002,
Berkshire Bank had the ability to borrow a total of approximately $254 million
from the Federal Home Loan Bank of Boston. At that date, Berkshire Bank had
outstanding advances of $133.0 million. In addition, Berkshire Bank had a $2.0
million repurchase agreement line of credit to be secured by securities or other
assets of Berkshire Bank with the Depositors Insurance Fund. At December 31,
2002, Berkshire Bank had no outstanding borrowings against this agreement.
- 19 -
The following tables present certain information regarding Berkshire
Bank's Federal Home Loan Bank advances during the periods and at the dates
indicated.
For the Years Ended December 31,
--------------------------------
2002 2001 2000
-------- -------- --------
(Dollars in thousands)
Maximum amount of advances
outstanding at any month end $146,053 $140,115 $112,158
Average advances outstanding 140,406 127,990 92,567
Weighted average rate paid
on advances 4.01% 5.17% 6.23%
At December 31,
--------------------------------
2002 2001 2000
-------- -------- --------
(Dollars in thousands)
Balance outstanding at end of year $133,002 $133,964 $101,386
Weighted average rate on advances
at end of year 3.27% 4.26% 6.18%
Berkshire Bank offers retail repurchase agreements to selected higher
balance customers and certain municipalities. These agreements are direct
obligations of Berkshire Bank to repay at maturity or on demand the purchase
price of an undivided interest in a U.S. Government or agency security owned by
Berkshire Bank. Since these agreements are not deposits, they are not insured by
the Federal Deposit Insurance Corporation. At December 31, 2002, such retail
repurchase agreement borrowings totaled $700,000.
The following tables represent certain information regarding Berkshire
Bank's retail repurchase agreements during the years and at the dates indicated.
--------------------------------
2002 2001 2000
-------- -------- --------
(Dollars in thousands)
Maximum amount of retail repurchase
agreements outstanding at any month end $ 1,830 $ 2,340 $ 2,980
Average retail repurchase agreements 1,349 1,584 1,683
outstanding
Weighted average rate paid on retail 1.72% 3.78% 5.88%
repurchase agreements
At December 31,
--------------------------------
2002 2001 2000
-------- -------- --------
(Dollars in thousands)
Balance outstanding at end of year $ 700 $ 1,890 $ 2,030
Weighted average rate on retail repurchase 1.59% 1.74% 6.00%
agreements at end of year
Trust Services
Berkshire Bank maintains the Asset Management/Trust Group as a department
within Berkshire Bank which primarily provides trust and investment services to
individuals, partnerships, corporations and institutions and also acts as a
fiduciary of estates and conservatorships and as a trustee under various wills,
trusts and other plans. The trust department allows Berkshire Bank to provide
investment opportunities and fiduciary services to both current and prospective
customers. Consistent with Berkshire Bank's operating strategy, Berkshire Bank
will continue to emphasize the growth of its trust service operations to grow
assets and increase fee-based income. Berkshire Bank has implemented several
policies governing the practices and procedures of the trust department,
including policies relating to maintaining confidentiality of trust records,
investment of trust property, handling conflicts of interest, and maintaining
impartiality. At December 31, 2002, the trust department managed 733 accounts
with aggregate assets of $244.1 million, of which the largest relationship
totaled $13.2 million, or 5.4%, of the trust department's total assets. Trust
fees totaled $1.8 million for both 2002 and 2001.
- 20 -
Government Banking
In 1998, Berkshire Bank began offering full service government banking for
cities, towns and municipal school districts in western Massachusetts and
southern Vermont. Berkshire Bank offers municipalities all aspects of financial
advisory services for the sale of notes and bonds, actively working with bond
counsel, rating agencies, consulting agencies and bond buyers. Additionally,
Berkshire Bank offers a wide range of municipal deposit products and checking
accounts, as well as the origination of payroll accounts. At December 31, 2002,
Berkshire Bank was working with approximately 60 municipal entities. For 2002,
government banking generated $180,000 of net fee income compared to $117,000 for
2001.
Personnel
As of December 31, 2002, Berkshire Bank had 245 full-time employees and 32
part-time employees. The employees are not represented by a collective
bargaining unit and the Bank will strive to continue its strong relationship
with its employees.
Subsidiary Activities
The following are descriptions of Berkshire Bank's active subsidiaries,
all of which are wholly owned except for Gold Leaf Capital Corporation which is
majority-owned. All subsidiaries are incorporated in Massachusetts and are
indirectly owned by Berkshire Hills.
G.B.S.B., Inc. G.B.S.B., Inc. was established in August 1990 as a
securities corporation to acquire and hold investment securities of a type that
are permissible for banks to hold under applicable law. In December 2002,
G.B.S.B., Inc was dissolved as assets totaling $14.5 million were transferred to
Berkshire Bank and assets totaling $7.7 million were transferred to North Street
Securities Corporation.
North Street Securities Corporation. North Street Securities Corporation,
("North Street") originally named GBSB Leasing Corporation, was established in
January 1984 to acquire and hold investment securities of a type that are
permissible for banks to hold under applicable law. North Street was qualified
as a "securities corporation" for Massachusetts income tax purposes. Income
earned by a qualifying securities corporation is generally entitled to special
tax treatment from Massachusetts income tax. As of December 31, 2002, North
Street had assets totaling $47.5 million, consisting primarily of municipal
bonds, corporate bonds and private label REMICs.
Gold Leaf Investment Services, Inc. Gold Leaf Investment Services, Inc.,
established in May 2000, began operations during the first quarter of 2001. Gold
Leaf Investment Services offers access to a full range of security brokerage
services, including financial planning, professional money management, stocks,
bonds, mutual funds, and annuities. These services are available through a
partnership with UVEST Investment Services, a registered securities
broker/dealer and member NASD/SIPC and are available in all of the Bank's
branches.
Gold Leaf Insurance Agency, Inc. Gold Leaf Insurance Agency, Inc.,
established in May 2000, began operations during the third quarter of 2000. Gold
Leaf Insurance Agency offers a full line of products including automobile, home,
business, and life insurance.
Gold Leaf Capital Corporation. Gold Leaf Capital Corporation was
established in April 2001 as a direct operating subsidiary of the Bank intended
to satisfy the requirements to qualify for treatment as a real estate investment
trust ("REIT"). The REIT was formed to invest in mortgage loans and
mortgage-backed securities. Currently, Gold Leaf Capital has solely invested in
mortgage loans originated by Berkshire Bank.
Woodland Securities, Inc. Woodland Securities, Inc. ("Woodland"),
originally named Woodland Realty, Inc., was established in April 1995 to
purchase, own, sell, develop and lease real property and personal property of
all types. Inactive for a number of years, Woodland converted to a Massachusetts
securities corporation in 2002 to acquire and hold investment securities of a
type that are permissible for banks to hold under applicable law. As of December
31, 2002, Woodland had assets of $86.2 million consisting primarily of callable
Agency securities and Agency REMICS.
Excluding Berkshire Bank, the following are descriptions of Berkshire
Hills' wholly owned active subsidiaries. All of Berkshire Hills' subsidiaries,
including Berkshire Bank, are incorporated in Massachusetts.
Berkshire Hills Funding Corporation. Berkshire Hills Funding Corporation
was established in May 2000 as a general purpose funding vehicle for Berkshire
Hills. Outside of cash, its sole asset is a loan to Berkshire Bank's Employee
Stock Ownership Plan ("ESOP"). The proceeds of such loan were used to fund the
ESOP trustee's purchase of Berkshire Hills common stock.
Berkshire Hills Technology, Inc. Berkshire Hills Technology, Inc., was
established in May 2001 to invest in, own, and sell any type of business
enterprise including, but not limited to, corporations and limited liability
companies. In June 2001, along
- 21 -
with a consortium of five other financial institutions, Berkshire Hills
Technology, Inc. announced its investment of $4.7 million in EastPoint
Technologies, LLC ("EastPoint"). The Company's equity interest in EastPoint
equals 60.3%. EastPoint, headquartered in Bedford, New Hampshire, is a software
and data processing provider for financial institutions.
Segment Reporting
Through its wholly-owned subsidiary, Berkshire Hills Technology, Inc., the
Company owns a 60.3% equity interest in EastPoint Technologies, LLC. Prior to
the acquisition of EastPoint, management monitored the revenue streams of the
various products and services in evaluating the Company's operations and
financial performance. Accordingly, all of the Company's operations were
considered by management to be aggregated in one reportable operating segment.
Subsequent to the acquisition of EastPoint, the Company's operations continue to
be aggregated in one reportable segment, the Bank, except Berkshire Hills
Technology, Inc., which is evaluated on a stand-alone basis.
Information about reportable segments, and the reconciliation of such
information to the consolidated financial statements as of and for the years
ended December 31, 2002 and 2001 follows:
2002
---------------------------------------------------
Berkshire Hills Consolidated
Bank Technology, Inc. Totals
----------- ---------------- ------------
(In thousands)
Net interest income $ 64,128 $ -- $ 64,128
Depreciation and amortization 1,813 601 2,414
Provision for loan losses 6,180 -- 6,180
License fees -- 6,991 6,991
Minority interest -- (685) (685)
Profit (loss) 2,809 (1,040) 1,769
Assets 1,037,047 8,571 1,045,618
Expenditures for additions to
premises and equipment 1,042 426 1,468
2001
---------------------------------------------------
Berkshire Hills Consolidated
Bank Technology, Inc. Totals
----------- ---------------- ------------
(In thousands)
Net interest income $ 75,796 $ -- $ 75,796
Depreciation and amortization 1,769 312 2,081
Provision for loan losses 7,175 -- 7,175
License fees -- 3,465 3,465
Minority interest -- (119) (119)
Profit (loss) 8,868 43 8,911
Assets 1,021,623 9,078 1,030,701
Expenditures for additions to
premises and equipment 2,147 1,806 3,953
The Company does not allocate income taxes to its segments, but rather,
assigns all taxes to the Bank. Berkshire Hills Technology's results include only
six months of fees and expenses for EastPoint in 2001 as compared to twelve
months in 2002 as EastPoint was purchased in June 2001.
REGULATION AND SUPERVISION
General
As a savings and loan holding company, Berkshire Hills is required to file
reports with, and otherwise comply with the rules and regulations of, the Office
of Thrift Supervision ("OTS"). As a savings bank chartered by the Commonwealth
of Massachusetts, Berkshire Bank is subject to extensive regulation, examination
and supervision by the Massachusetts Commissioner of Banks, as its primary
regulator, and the Federal Deposit Insurance Corporation, as the deposit
insurer.
- 22 -
Berkshire Bank is a member of the Federal Home Loan Bank system and, with
respect to deposit insurance, of the Bank Insurance Fund managed by the Federal
Deposit Insurance Corporation. Berkshire Bank must file reports with the
Commissioner of Banks and the Federal Deposit Insurance Corporation concerning
its activities and financial condition in addition to obtaining regulatory
approvals prior to entering into certain transactions such as mergers with, or
acquisitions of, other savings institutions. The Commissioner of Banks and /or
the Federal Deposit Insurance Corporation conduct periodic examinations to test
Berkshire Bank's safety and soundness and compliance with various regulatory
requirements. This regulation and supervision establishes a comprehensive
framework of activities in which an institution can engage and is intended
primarily for the protection of the insurance fund and depositors. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such regulatory requirements and policies, whether by the Commissioner
of Banks, the Federal Deposit Insurance Corporation or Congress, could have a
material adverse impact on the Company, the Bank and their operations. Certain
regulatory requirements applicable to Berkshire Bank and to the Company are
referred to below or elsewhere herein. The description of statutory provisions
and regulations applicable to savings institutions and their holding companies
set forth in this Form 10-K does not purport to be a complete description of
such statutes and regulations and their effects on Berkshire Bank and Berkshire
Hills.
Massachusetts Banking Laws and Supervision
Massachusetts's savings banks are regulated and supervised by the
Massachusetts Commissioner of Banks. The Massachusetts Commissioner of Banks is
required to regularly examine each state-chartered bank. The approval of the
Massachusetts Commissioner of Banks is required to establish or close branches,
to merge with another bank, to form a holding company, to issue stock or to
undertake many other activities. Any Massachusetts bank that does not operate in
accordance with the regulations, policies and directives of the Massachusetts
Commissioner of Banks may be sanctioned. The Massachusetts Commissioner of Banks
may suspend or remove directors or officers of a bank who have violated the law,
conducted a bank's business in a manner which is unsafe, unsound or contrary to
the depositors' interests, or been negligent in the performance of their duties.
In addition, the Massachusetts Commissioner of Banks has the authority to
appoint a receiver or conservator if it is determined that the bank is
conducting its business in an unsafe or unauthorized manner, and under certain
other circumstances.
All Massachusetts-chartered savings banks are required to be members of
the Depositors Insurance Fund and as such must pay its assessments. The
Depositors Insurance Fund is a private deposit insurer which insures all
deposits in member banks in excess of Federal Deposit Insurance Corporation
deposit insurance limits. In addition, the Mutual Savings Central Fund acts as a
source of liquidity to its members in supplying them with low-cost funds, and
purchasing qualifying obligations from them.
The powers which Massachusetts-chartered savings banks can exercise under
these laws are summarized below.
Lending Activities.
A Massachusetts-chartered savings bank may make a wide variety of mortgage
loans including fixed-rate loans, adjustable-rate loans, variable-rate loans,
participation loans, graduated payment loans, construction and development
loans, condominium and co-operative loans, second mortgage loans and other types
of loans that may be made in accordance with applicable regulations. Commercial
loans may be made to corporations and other commercial enterprises with or
without security. Consumer and personal loans may also be made with or without
security. Loans to individual borrowers generally must be limited to 20% of the
total of a bank's capital accounts and stockholders' equity.
Investments Authorized. Massachusetts-chartered savings banks have broad
investment powers under Massachusetts law, including so-called "leeway"
authority for investments that are not otherwise specifically authorized. The
investment powers authorized under Massachusetts law are restricted by federal
law to permit, in general, only investments of the kinds that would be permitted
for national banks. Berkshire Bank has authority to invest in all of the classes
of loans and investments that are permitted by its existing loan and investment
policies.
Payment of Dividends. A savings bank may only pay dividends on its capital
stock if such payment would not impair the bank's capital stock. No dividends
may be paid to stockholders of a bank if such dividends would reduce
stockholders' equity of the bank below the amount of the liquidation account
required by Massachusetts conversion regulations. Additionally, the
Massachusetts Commissioner of Banks may restrict the payment of dividends by a
bank if it was determined that such payment would result in safety and soundness
concerns.
Parity Regulation. Effective November 19, 2002, Massachusetts law was
amended to increase the powers of Massachusetts banks under certain conditions.
As a result of such amendment, Massachusetts law permits a Massachusetts bank to
engage in any activity or offer any product or service if the activity, product
or service is engaged in or offered in accordance with regulations promulgated
by the Massachusetts Commissioner of Banks and has been authorized for national
banks, federal thrifts or state banks in a state other than Massachusetts;
provided that the activity is permissible under applicable federal and
Massachusetts law and subject to the same limitations and restrictions imposed
on the national bank, federal thrift or out-of-state bank that had previously
been granted the power.
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Assessments. Savings banks are required to pay assessments to the
Commissioner of Banks to fund operations. Assessments paid by Berkshire Bank for
the fiscal year ended December 31, 2002 totaled $144,900.
Federal Regulations
Capital Requirements. Under Federal Deposit Insurance Corporation
regulations, federally insured state-chartered banks that are not members of the
Federal Reserve system ("state non-member banks"), such as Berkshire Bank, are
required to comply with minimum leverage capital requirements. For an
institution determined by the Federal Deposit Insurance Corporation to not be
anticipating or experiencing significant growth and to be in general a strong
banking organization, rated composite 1 under the Uniform Financial Institutions
Ranking System established by the Federal Financial Institutions Examination
Council, the minimum capital leverage requirement is a ratio of Tier 1 capital
to total assets of 3%. For all other institutions, the minimum leverage capital
ratio is not less than 4%. Tier 1 capital is the sum of common stockholders'
equity, non-cumulative perpetual preferred stock (including any related surplus)
and minority investments in certain subsidiaries, less intangible assets (except
for certain servicing rights and credit card relationships) and a percentage of
certain nonfinancial equity investments.
Berkshire Bank must also comply with the Federal Deposit Insurance
Corporation risk-based capital guidelines. The Federal Deposit Insurance
Corporation guidelines require state non-member banks to maintain certain levels
of regulatory capital in relation to regulatory risk-weighted assets. The ratio
of regulatory capital to regulatory risk-weighted assets is referred to as
Berkshire Bank's "risk-based capital ratio." Risk-based capital ratios are
determined by allocating assets and specified off-balance sheet items to four
risk-weighted categories ranging from 0% to 100%, with higher levels of capital
being required for the categories perceived as representing greater risk. For
example, under the Federal Deposit Insurance Corporation's risk-weighting
system, cash and securities backed by the full faith and credit of the U.S.
Government are given a 0% risk weight, loans secured by one- to four-family
residential properties generally have a 50% risk weight and commercial loans
have a risk weighting of 100%.
State non-member banks must maintain a minimum ratio of total capital to
risk-weighted assets of at least 8%, of which at least one-half must be Tier 1
capital. Total capital consists of Tier 1 capital plus Tier 2 or supplementary
capital items, which include allowances for loan losses in an amount of up to
1.25% of risk-weighted assets, cumulative preferred stock, a portion of the net
unrealized gain on equity securities and other capital instruments. The
includable amount of Tier 2 capital cannot exceed the amount of the
institution's Tier 1 capital.
The Federal Deposit Insurance Corporation Improvement Act required each
federal banking agency to revise its risk-based capital standards for insured
institutions to ensure that those standards take adequate account of interest
rate risk, concentration of credit risk, and the risk of nontraditional
activities, as well as to reflect the actual performance and expected risk of
loss on multi-family residential loans. The Federal Deposit Insurance
Corporation, along with the other federal banking agencies, has adopted a
regulation providing that the agencies will take into account the exposure of a
bank's capital and economic value to changes in interest rate risk in assessing
a bank's capital adequacy. Additionally, the Bank through its capital management
and risk assessment policies may determine to maintain capital levels in excess
of its regulatory required minimums. In this regard, with the recent performance
and level of the Bank's sub-prime automobile loan portfolio, management
considers the amount of such portfolios in determining the level of capital it
believes to be adequate.
As a savings and loan holding company regulated by the Office of Thrift
Supervision, Berkshire Hills is not, under current law, subject to any prompt
corrective action provisions.
The following is a summary of Berkshire Bank's regulatory capital at
December 31, 2002:
GAAP Capital to Total Assets 11.50%
Total Capital to Risk-Weighted Assets 13.55%
Tier I Leverage Ratio 8.78%
Tier I to Risk-Weighted Assets 11.81%
Standards for Safety and Soundness. The federal banking agencies adopted
regulations and Interagency Guidelines Establishing Standards for Safety and
Soundness to implement safety and soundness standards. The guidelines set forth
the safety and soundness standards that the federal banking agencies use to
identify and address problems at insured depository institutions before capital
becomes impaired. The guidelines address internal controls and information
systems, internal audit system, credit underwriting, loan documentation,
interest rate risk exposure, asset growth, asset quality, earnings and
compensation, and fees and benefits. If the appropriate federal banking agency
determines that an institution fails to meet any standard prescribed by the
guidelines, the agency may require the institution to submit to the agency an
acceptable plan to achieve compliance with the standard.
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Investment Activities
Under federal law, all state-chartered Federal Deposit Insurance
Corporation insured banks, including savings banks, have generally been limited
to activities as principal and equity investments of the type and in the amount
authorized for national banks, notwithstanding state law. The Federal Deposit
Insurance Corporation Improvement Act and the Federal Deposit Insurance
Corporation permit exceptions to these limitations. For example, state chartered
banks, such as Berkshire Bank, may, with Federal Deposit Insurance Corporation
approval, continue to exercise state authority to invest in common or preferred
stocks listed on a national securities exchange or the Nasdaq National Market
and in the shares of an investment company registered under federal law. In
addition, the Federal Deposit Insurance Corporation is authorized to permit such
institutions to engage in state authorized activities or investments that do not
meet this standard (other than non-subsidiary equity investments) for
institutions that meet all applicable capital requirements if it is determined
that such activities or investments do not pose a significant risk to the Bank
Insurance Fund. All non-subsidiary equity investments, unless otherwise
authorized or approved by the Federal Deposit Insurance Corporation, must have
been divested by December 19, 1996, under a Federal Deposit Insurance
Corporation approved divestiture plan, unless such investments were
grandfathered by the Federal Deposit Insurance Corporation. Berkshire Bank
received grandfathered authority from the Federal Deposit Insurance Corporation
in February 1993 to invest in listed stocks and/or registered shares. However,
the maximum permissible investment is 100% of Tier 1 capital, as specified by
the Federal Deposit Insurance Corporation's regulations, or the maximum amount
permitted by Massachusetts law, whichever is less. The Federal Deposit Insurance
Corporation also required that Berkshire Bank provide prior notice to the agency
if it increases the holdings of listed stock and/or registered shares as a
percentage of Tier 1 equity capital by 25%. Such grandfathered authority may be
terminated upon the Federal Deposit Insurance Corporation's determination that
such investments pose a safety and soundness risk to Berkshire Bank or if
Berkshire Bank converts its charter or undergoes a change in control. As of
December 31, 2002, Berkshire Bank had marketable equity securities including
money market preferred stocks with a market value of $19.6 million which were
held under such grandfathering authority.
Interstate Banking and Branching
Beginning June 1, 1997, the Interstate Banking Act permitted the
responsible federal banking agencies to approve merger transactions between
banks located in different states, regardless of whether the merger would be
prohibited under the law of the two states. The Interstate Banking Act also
permitted a state to "opt in" to the provisions of the Interstate Banking Act
before June 1, 1997, and permitted a state to "opt out" of the provisions of the
Interstate Banking Act by adopting appropriate legislation before that date.
Accordingly, beginning June 1, 1997, the Interstate Banking Act permitted a bank
to acquire an institution by merger in a state other than Massachusetts unless
the other state had opted out of the Interstate Banking Act. The Interstate
Banking Act also authorizes de novo branching into another state if the host
state enacts a law expressly permitting out of state banks to establish such
branches within its borders.
Prompt Corrective Regulatory Action
Federal law requires, among other things, that federal bank regulatory
authorities take "prompt corrective action" with respect to banks that do not
meet minimum capital requirements. For these purposes, the law establishes five
capital categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized.
The Federal Deposit Insurance Corporation has adopted regulations to
implement the prompt corrective action legislation. An institution is deemed to
be "well capitalized" if it has a total risk-based capital ratio of 10% or
greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage
ratio of 5% or greater. An institution is "adequately capitalized" if it has a
total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital
ratio of 4% or greater, and generally a leverage ratio of 4% or greater. An
institution is "undercapitalized" if it has a total risk-based capital ratio of
less than 8%, a Tier 1 risk-based capital ratio of less than 4%, or generally a
leverage ratio of less than 4% (3% or less for institutions with the highest
examination rating). An institution is deemed to be "significantly
undercapitalized" if it has a total risk-based capital ratio of less than 6%, a
Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of less
than 3%. An institution is considered to be "critically undercapitalized" if it
has a ratio of tangible equity (as defined in the regulations) to total assets
that is equal to or less than 2%. As of December 31, 2002, Berkshire Bank met
the conditions to be classified a "well capitalized" institution.
"Undercapitalized" banks must adhere to growth, capital distribution
(including dividend) and other limitations and are required to submit a capital
restoration plan. No institution may make a capital distribution, including
payment as a dividend, if it would be "undercapitalized" after the payment. A
bank's compliance with such plan is required to be guaranteed by any company
that controls the undercapitalized institution in an amount equal to the lesser
of 5% of the institution's total assets when deemed undercapitalized or the
amount necessary to achieve the status of adequately capitalized. If an
"undercapitalized" bank fails to submit an acceptable plan, it is treated as if
it is "significantly undercapitalized." "Significantly undercapitalized" banks
must comply with one or more of a number of additional restrictions, including
but not limited to an order by the Federal Deposit Insurance Corporation to sell
sufficient voting stock to become adequately capitalized, requirements to reduce
total assets and cease receipt of deposits from correspondent banks or dismiss
directors or officers, and restrictions on interest rates paid on deposits,
compensation of executive officers and capital distributions by the parent
holding company. "Critically undercapitalized" institutions must comply with
additional sanctions including, subject to a narrow exception, the appointment
of a receiver or conservator within 270 days after it obtains such status.
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Transactions with Affiliates
Under current federal law, transactions between depository institutions
and their affiliates are governed by Sections 23A and 23B of the Federal Reserve
Act. In a holding company context, at a minimum, the parent holding company of a
savings bank and any companies which are controlled by such parent holding
company are affiliates of the savings bank. Generally, Section 23A limits the
extent to which the savings bank or its subsidiaries may engage in "covered
transactions" with any one affiliate to 10% of such savings bank's capital stock
and surplus, and contains an aggregate limit on all such transactions with all
affiliates to 20% of capital stock and surplus. The term "covered transaction"
includes, among other things, the making of loans or other extensions of credit
to an affiliate and the purchase of assets from an affiliate. Section 23A also
establishes specific collateral requirements for loans or extensions of credit
to, or guarantees, acceptances on letters of credit issued on behalf of an
affiliate. Section 23B requires that covered transactions and a broad list of
other specified transactions be on terms substantially the same, or no less
favorable, to the savings bank or its subsidiary as similar transactions with
non-affiliates.
Further, federal law restricts an institution with respect to loans to
directors, executive officers, and principal stockholders ("insiders"). Loans to
insiders and their related interests may not exceed, together with all other
outstanding loans to such persons and affiliated entities, the institution's
total capital and surplus. Loans to insiders above specified amounts must
receive the prior approval of the board of directors. Further, loans to insiders
must be made on terms substantially the same as offered in comparable
transactions to other persons, except that such insiders may receive
preferential loans made under a benefit or compensation program that is widely
available to Berkshire Bank's employees and does not give preference to the
insider over the employees. Federal law places additional limitations on loans
to executive officers.
Enforcement
The Federal Deposit Insurance Corporation has extensive enforcement
authority over insured savings banks, including Berkshire Bank. This enforcement
authority includes, among other things, the ability to assess civil money
penalties, to issue cease and desist orders and to remove directors and
officers. In general, these enforcement actions may be initiated in response to
violations of laws and regulations and unsafe or unsound practices.
The Federal Deposit Insurance Corporation has authority under federal law
to appoint a conservator or receiver for an insured bank under limited
circumstances. The Federal Deposit Insurance Corporation is required, with
certain exceptions, to appoint a receiver or conservator for an insured state
non-member bank if that bank was "critically undercapitalized" on average during
the calendar quarter beginning 270 days after the date on which the institution
became "critically undercapitalized." (See Prompt Corrective Regulatory Action)
The Federal Deposit Insurance Corporation may also appoint itself as conservator
or receiver for an insured state non-member institution under specific
circumstances on the basis of the institution's financial condition or upon the
occurrence of other events, including: (1) insolvency; (2) substantial
dissipation of assets or earnings through violations of law or unsafe or unsound
practices; (3) existence of an unsafe or unsound condition to transact business;
and (4) insufficient capital, or the incurring of losses that will deplete
substantially all of the institution's capital with no reasonable prospect of
replenishment without federal assistance.
Insurance of Deposit Accounts
The Federal Deposit Insurance Corporation has adopted a risk-based
insurance assessment system. The Federal Deposit Insurance Corporation assigns
an institution to one of three capital categories based on the institution's
financial information consisting of (1) well capitalized, (2) adequately
capitalized or (3) undercapitalized, and one of three supervisory subcategories
within each capital group. The supervisory subgroup to which an institution is
assigned is based on a supervisory evaluation provided to the Federal Deposit
Insurance Corporation by the institution's primary federal regulator and
information which the Federal Deposit Insurance Corporation determines to be
relevant to the institution's financial condition and the risk posed to the
deposit insurance funds. An institution's assessment rate depends on the capital
category and supervisory category to which it is assigned. Assessment rates for
insurance fund deposits currently range from 0 basis points for the strongest
institution to 27 basis points for the weakest. Bank Insurance Fund members are
also required to assist in the repayment of bonds issued by the Financing
Corporation in the late 1980s to recapitalize the Federal Savings and Loan
Insurance Corporation. Effective January 1, 2000, full pro rata sharing of the
payments between Bank Insurance Fund members and Savings Association Insurance
Fund members commenced. The Federal Deposit Insurance Corporation is authorized
to raise the assessment rates. The Federal Deposit Insurance Corporation has
exercised this authority several times in the past and may raise insurance
premiums in the future. If such action is taken by the Federal Deposit Insurance
Corporation, it could have an adverse effect on the earnings of Berkshire Bank.
The Federal Deposit Insurance Corporation may terminate insurance of
deposits if it finds that the institution is in an unsafe or unsound condition
to continue operations, has engaged in unsafe or unsound practices, or has
violated any applicable law, regulation, rule, order or condition imposed by the
Federal Deposit Insurance Corporation. The management of the Bank does not know
of any practice, condition or violation that might lead to termination of
deposit insurance.
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Berkshire Bank, as a member of the Depositor Insurance Fund, is also
subject to its assessments. See "- Massachusetts Banking Laws and Supervision."
Federal Reserve System
The Federal Reserve Board regulations require depository institutions to
maintain noninterest-earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The Federal Reserve Board
regulations currently require that reserves be maintained against aggregate
transaction accounts as follows: for that portion of transaction accounts
aggregating $42.1 million less an exemption of $6.0 million (which may be
adjusted by the Federal Reserve Board) the reserve requirement is 3%; and for
accounts greater than $42.1 million, the reserve requirement is $1.1 million
plus 10% (which may be adjusted by the Federal Reserve Board between 8% and 14%)
of the portion in excess of $42.1 million. Berkshire Bank is in compliance with
these requirements.
Community Reinvestment Act
Under the Community Reinvestment Act, as implemented by Federal Deposit
Insurance Corporation regulations, a state non-member bank has a continuing and
affirmative obligation consistent with its safe and sound operation to help meet
the credit needs of its entire community, including low and moderate-income
neighborhoods. The Community Reinvestment Act neither establishes specific
lending requirements or programs for financial institutions nor limits an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community. The Community Reinvestment
Act requires the Federal Deposit Insurance Corporation, in connection with its
examination of an institution, to assess the institution's record of meeting the
credit needs of its community and to consider such record when it evaluates
applications made by such institution. The Community Reinvestment Act requires
public disclosure of an institution's Community Reinvestment Act rating.
Berkshire Bank's latest Community Reinvestment Act rating received from the
Federal Deposit Insurance Corporation was "Outstanding."
Berkshire Bank is also subject to similar obligations under Massachusetts
law which has an additional CRA rating category. The Massachusetts Community
Reinvestment Act requires the Massachusetts Banking Commissioner to consider a
bank's Massachusetts Community Reinvestment Act rating when reviewing a bank's
application to engage in certain transactions, including mergers, asset
purchases and the establishment of branch offices or automated teller machines,
and provides that such assessment may serve as a basis for the denial of such
application. Berkshire Bank's latest Massachusetts Community Reinvestment Act
rating received from the Massachusetts Division of Banks was "Outstanding."
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank system, which consists
of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a
central credit facility primarily for member institutions. Berkshire Bank, as a
member of the Federal Home Loan Bank of Boston, is required to acquire and hold
shares of capital stock in the Federal Home Loan Bank of Boston in an amount at
least equal to 1% of the aggregate principal amount of its unpaid residential
mortgage loans and similar obligations at the beginning of each year, or 1/20 of
its advances (borrowings) from the Federal Home Loan Bank of Boston, whichever
is greater. Berkshire Bank was in compliance with this requirement with an
investment in Federal Home Loan Bank of Boston stock at December 31, 2002 of
$7.4 million.
The Federal Home Loan Banks are required to provide funds for certain
purposes including contributing funds for affordable housing programs. These
requirements could reduce the amount of dividends that the Federal Home Loan
Banks pay to their members and result in the Federal Home Loan Banks imposing a
higher rate of interest on advances to their members. For the years ended 2002,
2001, 2000, 1999 and 1998, cash dividends from the Federal Home Loan Bank of
Boston to Berkshire Bank amounted to approximately $283,300, $303,600, $332,700,
$180,900 and $163,600, respectively. Further, there can be no assurance that the
impact of recent or future legislation on the Federal Home Loan Banks will not
also cause a decrease in the value of the Federal Home Loan Bank stock held by
the Bank.
Holding Company Regulation
Federal law allows a state savings bank that qualifies as a "Qualified
Thrift Lender," discussed below, to elect to be treated as a savings association
for purposes of the savings and loan holding company provisions of federal law.
Such election allows its holding company to be regulated as a savings and loan
holding company by the Office of Thrift Supervision rather than as a bank
holding company by the Federal Reserve Board. Berkshire Bank made such election
and the Company is a non-diversified savings and loan holding company within the
meaning of federal law. As such, the Company is registered with the Office of
Thrift Supervision and has adhered to the Office of Thrift Supervision's
regulations and reporting requirements. In addition, the Office of Thrift
Supervision may examine and supervise the Company and the Office of Thrift
Supervision has enforcement authority over the Company and its non-savings
institution subsidiaries. Among other things, this authority permits
- 27 -
the Office of Thrift Supervision to restrict or prohibit activities that are
determined to be a serious risk to the subsidiary savings institution.
Additionally, Berkshire Bank is required to notify the Office of Thrift
Supervision at least 30 days before declaring any dividend to the Company. By
regulation, the Office of Thrift Supervision may restrict or prohibit the Bank
from paying dividends.
As a unitary savings and loan holding company, the Company is generally
not restricted as to the types of business activities in which it could engage.
The Gramm-Leach-Bliley Act of 1999 expanded the authority of bank holding
companies to affiliate with other financial services companies such as insurance
companies and investment banking companies. The Gramm-Leach-Bliley Act, however,
provided that unitary savings and loan holding companies may only engage in
activities permitted to a financial holding company under the legislation and
those permitted for a multiple savings and loan holding company. Unitary savings
and loan companies existing prior to May 4, 1999, such as the Company, were
grandfathered as to the unrestricted activities. Upon any non-supervisory
acquisition by the Company of another savings association as a separate
subsidiary, the Company would become a multiple savings and loan holding
company. Federal law limits the activities of a multiple savings and loan
holding company and its non-insured institution subsidiaries primarily to
activities permissible for bank holding companies under Section 4(c)(8) of the
Bank Holding Company Act, provided the prior approval of the Office of Thrift
Supervision is obtained, and to other activities authorized by Office of Thrift
Supervision regulation and to those permitted for financial holding companies.
Multiple savings and loan holding companies are generally prohibited from
acquiring or retaining more than 5% of a non-subsidiary company engaged in
activities other than those permitted by federal law.
Federal law prohibits a savings and loan holding company from, directly or
indirectly, acquiring more than 5% of the voting stock of another savings
association or savings and loan holding company or from acquiring such an
institution or company by merger, consolidation or purchase of its assets,
without prior written approval of the Office of Thrift Supervision. In
evaluating applications by holding companies to acquire savings associations,
the Office of Thrift Supervision considers the financial and managerial
resources and future prospects of the Company and the institution involved, the
effect of the acquisition on the risk to the insurance funds, the convenience
and needs of the community and competitive factors.
The Office of Thrift Supervision is prohibited from approving any
acquisition that would result in a multiple savings and loan holding company
controlling savings institutions in more than one state, except for (1)
interstate supervisory acquisitions by savings and loan holding companies; and
(2) the acquisition of a savings institution in another state if the laws of the
state of the target savings institution specifically permit such acquisitions.
To be regulated as a savings and loan holding company by the Office of
Thrift Supervision (rather than as a bank holding company by the Federal Reserve
Board), the Bank must qualify as a Qualified Thrift Lender. To qualify as a
Qualified Thrift Lender, the Bank must maintain compliance with the test for a
"domestic building and loan association," as defined in the Internal Revenue
Code, or with a Qualified Thrift Lender Test. Under the Qualified Thrift Lender
Test, a savings institution is required to maintain at least 65% of its
"portfolio assets" (total assets less: (1) specified liquid assets up to 20% of
total assets; (2) intangibles, including goodwill; and (3) the value of property
used to conduct business) in certain "qualified thrift investments" (primarily
residential mortgages and related investments, including certain mortgage-backed
and related securities) in at least 9 months out of each 12 month period. As of
December 31, 2002, Berkshire Bank maintained 79.6% of its portfolio assets in
qualified thrift investments.
Massachusetts Holding Company Regulation. In addition to the federal
holding company regulations, a bank holding company organized or doing business
in Massachusetts must comply with any regulation under the Massachusetts law.
The term "bank holding company," for the purposes of Massachusetts law, is
defined generally to include any company which, directly or indirectly, owns,
controls or holds with power to vote more than 25% of the voting stock of each
of two or more banking institutions, including commercial banks and state
co-operative banks, savings banks and savings and loan associations and national
banks, federal savings banks and federal savings and loan associations. In
general, a holding company controlling, directly or indirectly, only one banking
institution will not be deemed to be a bank holding company for the purposes of
Massachusetts law. Under Massachusetts law, the prior approval of the Board of
Bank Incorporation is required before: any company may become a bank holding
company; any bank holding company acquires direct or indirect ownership or
control of more than 5% of the voting stock of, or all or substantially all of
the assets of, a banking institution; or any bank holding company merges with
another bank holding company. Although the Company is not a bank holding company
for purposes of Massachusetts law, any future acquisition of ownership, control,
or the power to vote 25% or more of the voting stock of another banking
institution or bank holding company would cause it to become such. The Company
has no current plan or arrangement to acquire ownership or control, directly or
indirectly, of 25% or more of the voting stock of another banking institution.
Federal Securities Laws
The Company's common stock is registered with the Securities and Exchange
Commission under the Exchange Act. The Company is subject to the information,
proxy solicitation, insider trading restrictions and other requirements under
the Exchange Act.
The registration under the Securities Act of shares of common stock does
not cover the resale of such shares. Shares of the common stock purchased by
persons who are not affiliates of the Company may be resold without
registration. The resale
- 28 -
restrictions of Rule 144 under the Securities Act govern shares purchased by an
affiliate of the Company. If the Company meets the current public information
requirements of Rule 144 under the Securities Act, each affiliate of the Company
who complies with the other conditions of Rule 144 (including those that require
the affiliate's sale to be aggregated with those of other persons) would be able
to sell in the public market, without registration, a number of shares not to
exceed, in any three-month period, the greater of (1) 1% of the outstanding
shares of the Company or (2) the average weekly volume of trading in such shares
during the preceding four calendar weeks. Provision may be made in the future by
the Company to permit affiliates to have their shares registered for sale under
the Securities Act under specific circumstances.
FEDERAL AND STATE TAXATION ON INCOME
Federal Income Taxation
General. The Company and Berkshire Bank report their income on a calendar
year basis using the accrual method of accounting. The federal income tax laws
apply to the Company and Berkshire Bank in the same manner as to other
corporations with some exceptions, including particularly Berkshire Bank's
reserve for bad debts discussed below. The following discussion of tax matters
is intended only as a summary and does not purport to be a comprehensive
description of the tax rules applicable to Berkshire Bank or the Company.
Berkshire Bank's federal income tax returns have been either audited or closed
under the statute of limitations through tax year 1999. For its 2002 tax year,
Berkshire Bank's maximum federal income tax rate was 35%.
Bad Debt Reserves. For fiscal years beginning before December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986, as amended, were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans, generally secured
by interests in real property improved or to be improved, under the percentage
of taxable income method or the experience method. The reserve for
non-qualifying loans was computed using the experience method.
Federal legislation enacted in 1996 repealed the reserve method of
accounting for bad debts and the percentage of taxable income method for tax
years beginning after 1995 and required savings institutions to recapture or
take into income certain portions of their accumulated bad debt reserves.
Approximately $844,000 of the Bank's accumulated bad debt reserves would not be
recaptured into taxable income unless the Bank makes a "nondividend
distribution" to the Company as described below.
Distributions. If the Bank makes "nondividend distributions" to the
Company, they will be considered to have been made from the Bank's unrecaptured
tax bad debt reserves, including the balance of its reserves as of December 31,
1987, to the extent of the "nondividend distributions," and then from the Bank's
supplemental reserve for losses on loans, to the extent of those reserves, and
an amount based on the amount distributed, but not more than the amount of those
reserves, will be included in the Bank's taxable income. Nondividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of the Bank's current or accumulated earnings
and profits will not be so included in the Bank's taxable income.
The amount of additional taxable income triggered by a nondividend is an
amount that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Therefore, if the Bank makes a nondividend
distribution to the Company, approximately one and one-half times the amount of
the distribution not in excess of the amount of the reserves would be includable
in income for federal income tax purposes, assuming a 35% federal corporate
income tax rate. The Bank does not intend to pay dividends that would result in
a recapture of any portion of its bad debt reserves.
State Taxation
Massachusetts Taxation. The Massachusetts excise tax rate for savings
banks is currently 10.5% of federal taxable income, adjusted for certain items.
Taxable income includes gross income as defined under the Internal Revenue Code,
plus interest from bonds, notes and evidences of indebtedness of any state,
including Massachusetts, less deductions, but not the credits, allowable under
the provisions of the Internal Revenue Code, except no deduction is allowed for
taxes paid to the state which are based on income. Carryforwards and carrybacks
of net operating losses are not allowed.
A financial institution or business corporation is generally entitled to
special tax treatment as a "securities corporation," provided that: (a) its
activities are limited to buying, selling, dealing in or holding securities on
its own behalf and not as a broker; and (b) it has applied for, and received,
classification as a "securities corporation" by the Commissioner of the
Massachusetts Department of Revenue. A securities corporation that is also a
bank holding company under the Code must pay a tax equal to 0.33% of its gross
income. A securities corporation that is not a bank holding company under the
Code must pay a tax equal to 1.32% of its gross income. Two of the Bank's
subsidiaries, North Street Securities Corporation and Woodland Securities, Inc.,
are Massachusetts securities corporations.
- 29 -
In November 2002, the Bank received a "Notice of Intent to Assess" from
the Commonwealth of Massachusetts Department of Revenue ("DOR") and,
subsequently, in January 2003, received a "Notice of Assessment." The notices
indicate that the Bank owes approximately $770,000 in additional state taxes,
including interest, for the tax year ended December 31, 2001, related to the
denial by the DOR of the Bank's claim of a dividends received deduction for
dividends received from the Bank's real estate investment trust ("REIT")
subsidiary. There is no possible assessment relating to the December 31, 2002
return due to the loss incurred by the Bank on a separate company basis.
The DOR contends that dividend distributions by the Bank's subsidiary,
Gold Leaf Capital Corp. (the "Subsidiary") to the Bank are fully taxable in
Massachusetts. The Bank believes that the Massachusetts statute that provides
for a dividends received deduction equal to 95% of certain dividend
distributions applies to the distributions made by the Subsidiary to the Bank.
Accordingly, no provision has been made in the Bank's consolidated financial
statements for the amounts assessed or additional amounts that might be assessed
in the future. The Bank has appealed the assessment and will pursue all
available means to defend its position. Assessed amounts ultimately paid, if
any, would be deductible expenses for federal income tax purposes.
In January 2003, legislation was proposed in Massachusetts, which
prohibits use of the 95% dividends received deduction when the dividends are
received from a REIT, effective for the tax years beginning in 1999. On March 5,
2003, the Governor of Massachusetts signed the legislation. As a result, the
Company has ceased recording tax benefits associated with the dividends received
deduction effective for the 2003 tax year and accrued $513,000, representing the
amount of tax benefits realized by the Company through the dividends received
deduction through the 2002 tax year. Such amount includes interest assessed by
the Massachusetts Department of Revenue through December 31, 2002. The Company
intends to vigorously appeal the retroactive nature of the provision.
Delaware Taxation. As a Delaware holding company not earning income in
Delaware, the Company is exempt from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
Company Website and Availability of Securities and Exchange Commission Filings
The Company's Internet website is www.berkshirebank.com. The Company makes
available free of charge on or through its website, its annual reports on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable
after the Company electronically files such material with, or furnishes it to,
the Securities and Exchange Commission.
ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding the executive
officers of Berkshire Hills and/or Berkshire Bank.
Name Age(1) Position
---- ------ --------
Michael P. Daly 41 President and Chief Executive Officer
Robert A. Wells 63 Chairman of the Board
Charles F. Plungis, Jr. 51 Senior Vice President, Chief Financial Officer and Treasurer(2)
Wayne F. Patenaude 42 Senior Vice President, Chief Financial Officer and Treasurer(2)
Gayle P. Fawcett 50 Senior Vice President of Retail Banking and Operations of Berkshire
Bank
- ----------
(1) As of December 31, 2002.
(2) Mr. Plungis has retired as Senior Vice President, Chief Financial Officer
and Treasurer, effective on February 28, 2003. Berkshire Hills and
Berkshire Bank have named Mr. Patenaude as his successor, effective March
1, 2003.
The executive officers are elected annually and hold office until their
successors have been elected and qualified or until they are removed or
replaced.
Biographical Information
Michael P. Daly serves as President and Chief Executive Officer of the
Company and Berkshire Bank. Before being named to this position, Mr. Daly served
as Executive Vice President and Senior Loan Officer of Berkshire Bank and
Executive Vice President of the Company and Senior Vice President of Commercial
Banking.
Robert A. Wells is Chairman of the Board of the Company and Berkshire
Bank.
- 30 -
Charles F. Plungis, Jr. was Senior Vice President, Chief Financial Officer
and Treasurer of the Company and Berkshire Bank until his retirement effective
February 28, 2003.
Wayne F. Patenaude will be Senior Vice President, Chief Financial Officer
and Treasurer of the Company and Berkshire Bank, effective March 1, 2003. Mr.
Patenaude served as Executive Vice President, Chief Financial Officer and
Treasurer of American Savings Bank, located in New Britain, Connecticut, from
1999 until American Savings Bank's acquisition by Banknorth, N.A. on February
14, 2003. Prior to working for American, Mr. Patenaude was the Chief Financial
Officer and Treasurer of Southington Savings Bank located in Southington,
Connecticut from 1998 to 1999. Mr. Patenaude was Senior Vice President and Chief
Financial Officer of Glastonbury Bank & Trust Company from 1991 to 1998.
Gayle P. Fawcett is Senior Vice President of Retail Banking and Operations
of Berkshire Bank.
- 31 -
ITEM 2. PROPERTIES
The Company and the Bank currently conducts their business through the
main office located in Pittsfield, Massachusetts, and 11 other full service
banking offices and one other facility listed below. The Company and the Bank
believe that their facilities are adequate to meet their present and immediately
foreseeable needs.
Net Book Value
Original of Property
Lease Year Date of or Leasehold
Or Leased Lease Improvements at
Location Own or Acquired Expiration December 31, 2002
- -------- ----- ----------- ---------- -----------------
(In thousands)
Main Office
24 North Street
Pittsfield, Massachusetts Own 1898 -- $1,640
Banking Offices
244 Main Street
Great Barrington, Massachusetts Own 1950 -- 673
103 North Main Street
Sheffield, Massachusetts Own 1966 -- 193
Old Town Hall
43 East Street
Pittsfield, Massachusetts Lease 1969 2030 472
2 Depot Street
W. Stockbridge, Massachusetts Own 1975 -- 89
165 Elm Street
Pittsfield, Massachusetts Own 1977 -- 281
255 Stockbridge Road
Great Barrington, Massachusetts Own 1985 -- 233
37 Main Street
North Adams, Massachusetts Lease 1985 2005(1) 344
1 Park Street
Lee, Massachusetts Own 1991 -- 208
32 Main Street
Stockbridge, Massachusetts Own 1991 -- 275
66 West Street
Pittsfield, Massachusetts Lease 1998 2009(2) 91
Allendale Shopping Center
39 Cheshire Road
Pittsfield, Massachusetts Lease 2001 2021(3) 1,222
Other Office
66 Allen Street(4)
Pittsfield, Massachusetts Own 1999 -- 2,210
- ----------
(1) Berkshire Bank has one option to renew for ten years.
(2) Berkshire Bank has two options to renew each for an additional five-year
period.
(3) Berkshire Bank has four options to renew each for an additional five-year
period.
(4) This facility houses Berkshire Bank's Commercial Lending Division,
Investment Department, Asset Management/Trust Department and Government
Banking Program.
ITEM 3. LEGAL PROCEEDINGS
Periodically, there have been various claims and lawsuits involving
Berkshire Bank, such as claims to enforce liens, condemnation proceedings on
properties in which the Bank holds security interests, claims involving the
making and servicing of
- 32 -
real property loans and other issues incident to the Bank's business. The
Company is not a party to any pending legal proceedings that it believes would
have a material adverse effect on the financial condition or operations of the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock is traded on the American Stock Exchange under the symbol
"BHL." As of February 25, 2003, the Company had approximately 987 holders of
record. The following table sets forth, for the quarters indicated, the daily
closing high and low sales price for the Common Stock and the dividends paid.
The Company is subject to the requirements of Delaware law, which generally
limits dividends to an amount equal to the excess of the net assets of the
Company (the amount by which total assets exceed total liabilities) over its
statutory capital or, if there is no excess, to its net profits for the current
and/or immediately preceding fiscal year.
For the Year Ended December 31, 2002
-----------------------------------------------------------
4th Quarter 3rd Quarter 2nd Quarter 1st Quarter
----------- ----------- ----------- -----------
High $25.25 $27.25 $26.20 $22.08
Low $22.94 $20.99 $21.98 $19.65
Dividend Paid $ 0.12 $ 0.12 $ 0.12 $ 0.12
For the Year Ended December 31, 2001
-----------------------------------------------------------
4th Quarter 3rd Quarter 2nd Quarter 1st Quarter
----------- ----------- ----------- -----------
High $20.25 $19.90 $18.75 $18.65
Low $17.85 $16.75 $17.10 $15.13
Dividend Paid $ 0.11 $ 0.11 $ 0.11 $ 0.10
- 33 -
ITEM 6. SELECTED FINANCIAL DATA
The Company has derived the following selected consolidated financial and
other data of the Company and Berkshire Bank in part from the consolidated
financial statements and notes appearing elsewhere in this Form 10-K. The data
as of December 31, 2002, 2001 and 2000 are derived from the audited consolidated
financial statements for Berkshire Hills Bancorp and Berkshire Bank. The data as
of December 31, 1999 and 1998 and for the years then ended are derived from the
audited consolidated financial statements of Berkshire Bancorp and Berkshire
Bank.
At or For the Years Ended December 31,
------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
(In thousands, except per share data)
Selected Financial Data:
Total assets $ 1,045,618 $ 1,030,701 $ 1,011,340 $ 841,651 $ 780,289
Loans, net 712,714 791,920 783,405 665,554 599,171
Investment securities:
Available for sale 173,169 104,446 99,309 93,084 93,774
Held to maturity 44,267 33,263 32,238 17,014 23,780
Federal Home Loan Bank stock 7,440 7,027 5,651 3,843 2,547
Savings Bank Life Insurance stock 2,043 2,043 2,043 2,043 2,043
Deposits(1) 782,360 742,729 729,594 680,767 647,122
Federal Home Loan Bank advances 133,002 133,964 101,386 58,928 29,590
Repurchase agreements 700 1,890 2,030 1,120 7,000
Total stockholders' equity 120,240 139,323 161,322 88,352 84,201
Real estate owned 1,500 -- 50 220 398
Nonperforming loans 3,741 2,702 2,869 2,841 3,490
Selected Operating Data:
Total interest and dividend income $ 64,128 $ 75,796 $ 71,018 $ 58,468 $ 52,495
Total interest expense 23,428 33,560 33,468 26,922 24,182
----------- ----------- ----------- ----------- -----------
Net interest income 40,700 42,236 37,550 31,546 28,313
Provision for loan losses 6,180 7,175 3,170 3,030 2,055
----------- ----------- ----------- ----------- -----------
Net interest income after provision
for loan losses 34,520 35,061 34,380 28,516 26,258
----------- ----------- ----------- ----------- -----------
Noninterest income:
Service charges and fees 4,469 4,187 3,743 3,405 2,568
Gain on sales and dispositions of
securities, net 14,470 268 423 491 425
Loss on sale of loans (10,702) -- -- -- --
----------- ----------- ----------- ----------- -----------
Other(2) 5,181 6,093 580 402 300
----------- ----------- ----------- ----------- -----------
Total noninterest income 13,418 10,548 4,746 4,298 3,293
----------- ----------- ----------- ----------- -----------
Total noninterest expense 45,807 32,349 32,184 25,196 22,359
----------- ----------- ----------- ----------- -----------
Income before income taxes 2,131 13,260 6,942 7,618 7,192
Income taxes 362 4,349 2,360 1,995 2,768
----------- ----------- ----------- ----------- -----------
Net income $ 1,769 $ 8,911 $ 4,582 $ 5,623 $ 4,424
=========== =========== =========== =========== ===========
Dividends per share $ 0.48 $ 0.43 $ 0.10 N/A N/A
Earnings per share
Basic $ 0.33 $ 1.42 N/A N/A N/A
Diluted $ 0.30 $ 1.35 N/A N/A N/A
Book value per share $ 19.66 $ 21.68 $ 21.02 N/A N/A
- 34 -
At or For the Years Ended December 31,
------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
Selected Operating Ratios and Other Data(3):
Performance Ratios:
Average yield on interest-earning assets 6.49% 7.80% 8.04% 7.65% 7.83%
Average rate paid on interest-bearing
liabilities 2.85 4.25 4.64 4.15 4.36
Interest rate spread(4) 3.64 3.55 3.40 3.50 3.47
Net interest margin(5) 4.12 4.35 4.25 4.13 4.22
Interest-bearing assets to interest-bearing
liabilities 120.33 123.04 122.53 117.75 120.94
Net interest income after provision for loan
losses to noninterest expense 75.36 108.39 106.82 113.18 117.44
Noninterest expense as a percent of
average assets 4.36 3.13 3.44 3.09 3.19
Return on average assets(6) 0.17 0.86 0.49 0.69 0.63
Return on average equity(7) 1.30 5.74 3.72 6.51 5.56
Average equity to average assets 12.95 15.00 13.15 10.59 11.34
Dividend payout ratio(8) 145.45 30.28 N/A N/A N/A
Efficiency ratio(9) 77.27 61.60 76.86 71.27 71.71
Regulatory Capital Ratios:
Tier 1 capital to average assets 10.05 11.02 14.54 7.91 7.79
Total capital to risk-weighted assets 15.21 15.73 20.15 12.90 13.04
Asset Quality Ratios:
Nonperforming loans as a percent of total
loans(10) 0.52 0.34 0.36 0.42 0.58
Nonperforming assets as a percent of total
assets(11) 0.50 0.26 0.29 0.36 0.50
Allowance for loan losses as a percent of
total loans 1.43 1.37 1.29 1.27 1.25
Allowance for loan losses as a percent of
nonperforming loans 275.54 408.36 356.08 300.39 217.45
Net loans charged-off as a percent of
interest-earning loans 0.96 0.79 0.19 0.31 0.09
- ----------
(1) Includes mortgagors' escrow accounts.
(2) Consists primarily of Berkshire Hills Technology's revenues in 2002 and
2001. Berkshire Hills Technology did not exist prior to 2001.
(3) Regulatory Capital and Asset Quality Ratios are end of period ratios.
Performance Ratios are based on daily averages.
(4) Difference between weighted average yield on interest-earning assets and
weighted average cost of interest-bearing liabilities.
(5) Net interest income as a percentage of average interest-earning assets.
(6) Net income divided by average total assets.
(7) Net income divided by average total equity.
(8) Dividends per share divided by basic earnings per share. Comparable
figures for 2000, 1999 and 1998 are not available as the Company began
paying dividends in the fourth quarter of 2000.
(9) Operating expenses divided by net interest income plus other income, less
gain on sale of securities plus losses on sale of loans. For purposes of
the 2002 computation, the severance payments of $6.9 million were deducted
from operating expenses.
(10) Nonperforming loans consist of nonaccrual loans.
(11) Nonperforming assets consist of nonaccrual loans and real estate owned.
- 35 -
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
Management's discussion and analysis of financial condition and results of
operations is intended to assist in understanding the financial condition and
results of operations of the Company. The information contained in this section
should be read in conjunction with the consolidated financial statements and
accompanying notes contained in this report.
Forward-Looking Statements
This Annual Report on Form 10-K contains certain forward-looking
statements which are based on certain assumptions and describe future plans,
strategies and expectations of the Company. These forward-looking statements are
generally identified by use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project," or similar expressions. The Company's
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Factors which could have a material adverse effect on the
operations of the Company and the subsidiaries include, but are not limited to,
changes in interest rates, general economic conditions, legislative/regulatory
changes, monetary and fiscal policies of the U.S. Government, including policies
of the U.S. Treasury and the Federal Reserve Board, the quality or composition
of the loan or investment portfolios, demand for loan products, deposit flows,
competition, demand for financial services in the Company's market area and
accounting principles and guidelines. These risks and uncertainties should be
considered in evaluating forward-looking statements and undue reliance should
not be placed on such statements. The Company does not undertake -- and
specifically disclaims any obligation -- to publicly release the result of any
revisions which may be made to any forward-looking statements to reflect events
or circumstances after the date of such statements or to reflect the occurrence
of anticipated or unanticipated events.
Operating Strategy
The Bank is an independent, community-oriented savings bank, delivering
quality customer service and offering a wide range of deposit, loan and
investment products to its customers. In recent years, the Bank's strategy has
been to enhance profitability through controlled balance sheet growth by
emphasizing the origination of real estate mortgages, commercial loans and home
equity loans, increasing sources of noninterest income and by improving
operating efficiencies while managing its capital position and limiting its
credit and interest rate risk exposure. To accomplish these objectives, the Bank
has sought to:
o Operate as a full service community bank by expanding the services
and products it offers.
o Provide superior customer service and innovative products, by
increasing the functionality of its ATM network and expanding the
capability of its call center.
o Increase fee income by broadening non-depository product offerings
and services.
o Continue to increase its emphasis on high quality consumer and
commercial loans to maintain the yields earned on its overall loan
portfolio, without incurring unacceptable credit risk.
o Control credit risk by continuing to employ conservative
underwriting standards to minimize the level of new problem assets.
o Manage interest rate risk by emphasizing investments in shorter-term
loans and investment securities.
o Invest primarily in debt instruments and money market type equity
investments to provide adequate liquidity, to meet cash flow needs
and to earn a reasonable return on investment.
- 36 -
Fourth Quarter Events and Recent Developments
In 2002, as part of the Bank's effort to enhance its risk management
practices and lower its automobile loan exposure, especially its exposure to
indirect sub-prime automobile loans, the Bank discontinued the origination of
indirect sub-prime automobile loans. In December 2002, the Bank accelerated its
plan to exit the indirect sub-prime automobile loan business by selling $69.7
million of such loans, which resulted in charges of $11.2 million. The Bank will
continue to invest in indirect automobile loans, but not the sub-prime segment
of this market.
As part of a revised long-term business strategy, the Bank restructured
its investment portfolio placing less emphasis on equity securities. Equities
totaling $18.8 million were sold in December 2002 resulting in a gain of $14.8
million. Excluding Federal Home Loan Bank ("FHLB") and Savings Bank Life
Insurance ("SBLI") stock, equities comprised 9.0% of the investment portfolio at
December 31, 2002.
As part of its revised policy and procedures for reviewing and estimating
writedowns of repossessed assets, the Bank recognized a charge of $1.8 million
of which $1.3 million was the result of writing down the values of repossessed
automobiles and $500,000 was related to the writedown of one foreclosed
property. The Bank also increased its allowance for loan losses by $1.5 million
to reflect a lower estimate for recoverability of the Bank's remaining sub-prime
indirect automobile loans.
In December 2002, the Bank prepaid several higher-rate FHLB borrowings and
replaced them with lower rate, shorter-term FHLB borrowings. FHLB borrowings
totaling $21.2 million with a weighted average maturity of approximately 26
months and a weighted average interest rate of approximately 5.56% were replaced
by $20.0 million of FHLB borrowings with a weighted average maturity of nine
months at a weighted average cost of 1.53%. The Company incurred a prepayment
penalty of $1.1 million in the fourth quarter of 2002 to do so.
The Commonwealth of Massachusetts Department of Revenue notified Berkshire
Bank that it owes approximately $770,000 in additional state taxes, including
interest, for the tax year ended December 31, 2001, related to the denial by the
Department of Revenue of Berkshire Bank's claim for a deduction received from
dividends from Berkshire Bank's real estate investment trust subsidiary.
Berkshire Bank claims that the dividends it received were appropriate under
applicable law. Accordingly, Berkshire Bank has appealed the assessment and
provided no provision in the Company's consolidated financial statements.
Assessed amounts ultimately paid, if any, would be deductible expenses for
federal income tax purposes.
In January 2003, legislation was proposed in Massachusetts, which
prohibits use of the 95% dividends received deduction when the dividends are
received from a REIT, effective for the tax years beginning in 1999. On March 5,
2003, the Governor of Massachusetts signed the legislation. As a result, the
Company has ceased recording tax benefits associated with the dividends received
deduction effective for the 2003 tax year and accrued $513,000, representing the
amount of tax benefits realized by the Company through the dividends received
deduction through the 2002 tax year. Such amount includes interest assessed by
the Massachusetts Department of Revenue through December 31, 2002. The Company
intends to vigorously appeal the retroactive nature of the provision.
Comparison of Financial Condition at December 31, 2002 and 2001
Total assets were $1.05 billion at December 31, 2002, an increase of $14.9
million, or 1.4%, from $1.03 billion at December 31, 2001. An increase of $79.7
million in securities, excluding FHLB and SBLI stock, and an increase of $23.9
million in short-term investments more than offset a decrease of $79.8 million
in total loans outstanding. The Company's investment portfolio, excluding FHLB
and SBLI stock, increased 57.9% to $217.4 million at the end of 2002 from $137.7
million at the end of 2001 as proceeds from loan and equity sales were invested
in securities, primarily CMOs and callable Agency notes. Short-term investments
totaled $43.4 million at December 31, 2002, an increase of 122.9% from $19.5
million at December 31, 2001 reflecting the investment of excess funds. Loans
totaled $723.2 million at the end of 2002, a decrease of 9.9% from $803.0
million at the end of 2001. Automobile loans decreased $110.9 million, or 51.4%,
to $105.0 million at December 31, 2002 from $216.0 at December 31, 2001 as the
Bank looked to exit the indirect sub-prime automobile loan business by allowing
the Bank's balance of indirect sub-prime automobile loans to run off during much
of the year and, in December 2002, by selling $69.7 million of its remaining
indirect sub-prime automobile loans to a third party. At December 31, 2002,
$18.2 million of indirect sub-prime automobile loans remained. Construction and
land development loans decreased $5.3 million, or 23.1%, to $17.6 million at
December 31, 2002 from $22.9 million at December 31, 2001 as completed projects
converted to permanent financing. Somewhat offsetting these decreases were
increases in commercial real estate and residential one- to four-family loans.
Commercial real estate totaled $119.2 million at December 31, 2002, an increase
of $34.5 million, or 40.7%, from $84.7 million last year while residential one-
to four-family loans increased $6.1 million, or 2.5%, to $246.9 million at
December 31, 2002 from $240.9 million at December 31, 2001. Both of these
increases reflect a strong local real estate loan market and low market interest
rates. Commercial loans declined $4.8 million, or 2.8%, to $165.4 million
reflecting high principal prepayments.
Nonperforming loans totaled $3.7 million at December 31, 2002, an increase
of $1.0 million, or 38.5%, from $2.7 million at December 31, 2001. This increase
was primarily due to a rise in commercial nonaccruing loans which totaled $2.9
million at the end of 2002 compared to $2.1 million at the end of 2001,
reflecting one loan for $1.8 million being placed on
- 37 -
nonaccrual status. Nonaccruing consumer loans totaled $661,000 at the end of
2002 up from $315,000 at the end of 2001, reflecting the continued general
weakness in the economy. However, automobile loans in the amount of $590,000
were 90 days or more past due and still accruing interest at the end of 2002,
compared to $1.3 million at the end of 2001. The ratio of nonperforming loans to
total loans at December 31, 2002 and 2001 was 0.52% and 0.34%, respectively.
Real estate owned totaled $1.5 million at the end of 2002 compared to none for
last year as the Bank took possession of one commercial property in the first
quarter of 2002. On February 13, 2003 the Bank sold this property for $1.5
million.
Other assets declined $5.9 million, or 30.7%, to $13.3 million at December
31, 2002 from $19.2 million at December 31, 2001. As a direct result of the
Bank's sale of $69.7 million of indirect sub-prime automobile loans, prepaid
dealer reserves (the amount Berkshire Bank compensates the originator of an
indirect automobile loan) declined $5.1 million. The total value of repossessed
vehicles fell $1.7 million in 2002 due to declining used car prices and lowered
valuations placed on vehicles repossessed by the Bank. Repossessed vehicles are
priced at net realizable value including deductions made for expenses necessary
to prepare the vehicle for sale. The dealer reserve and repossessed automobile
decrease were somewhat offset by increases of $900,000 in various other assets.
Interest bearing liabilities increased $33.1 million, or 4.2%, to $828.9
million at December 31, 2002 from $795.8 million at December 31, 2001, due
primarily to a $35.2 million, or 5.3%, increase in interest bearing deposits to
$695.2 million at the end of 2002 from $660.0 million at the end of 2001.
Certificates of deposit and savings accounts increased $19.9 million while money
market and NOW accounts increased $15.4 million. Noninterest bearing demand
deposits grew $4.4 million to $87.1 million at December 31, 2002 from $82.8
million at December 31, 2001. FHLB borrowings and retail repurchase agreements
decreased $2.2 million to $133.7 million at the end of 2002 from $135.9 million
for the end of 2001.
Stockholders' equity totaled $120.2 million at December 31, 2002, a
decrease of $19.1 million, or 13.7%, from $139.3 million at December 31, 2001.
This decrease was primarily due to a $13.3 million decrease in accumulated other
comprehensive income resulting from the sale of equity securities by the Company
in 2002. Also impacting this decrease was the repurchase of 314,913 shares at a
cost of $7.0 million and the payment of $2.7 million of dividends, partially
offset by net income of $1.8 million.
Comparison of Operating Results for the Years Ended December 31, 2002 and 2001
Net Income. Net income totaled $1.8 million for the year ended December
31, 2002, a decrease of $7.1 million, or 80.1%, from $8.9 million for the year
ended December 31, 2001. Net income for 2002 includes $8.3 million in charges in
connection with the restructuring of the Company's senior management and the
reorganizing of the Company's long-term business strategy while net income for
2001 includes a one-time gain of $2.2 million from the dissolution of the Bank's
defined benefit pension plan. Basic and diluted earnings per share for the year
ended December 31, 2002 were $0.33 and $0.30, respectively, compared to basic
and diluted earnings of $1.42 and $1.35 for the year ended December 31, 2001.
Net Interest Income. Net interest income decreased $1.5 million, or 3.6%,
to $40.7 million in 2002 from $42.2 million in 2001 as the relatively low market
interest rate environment led to a high number of loan prepayments and
refinancings which had a negative impact on earnings. The average yield on
interest bearing assets declined 131 basis points to 6.49% for the year ended
December 31, 2002 compared to 7.80% for the year ended December 31, 2001 and
more than offset a $16.2 million increase in average interest bearing assets to
$987.9 million for 2002 compared to $971.7 million for 2001. Average interest
bearing liabilities increased $31.3 million to $821.0 million in 2002 from
$789.7 in 2001, but were more than offset by a lower average rate paid of 2.85%
in 2002 compared to 4.25% in 2001 reflecting the low market interest rate
environment. As a result, the Company's net interest margin for the twelve
months ended December 31, 2002 and 2001 were 4.12% and 4.35%, respectively.
Interest and dividend income fell $11.7 million, or 15.4%, to $64.1
million for 2002 from $75.8 million for 2001 as interest earned on the Bank's
loan portfolio dropped $11.4 million, or 16.7%, from $68.3 million for 2001 as
the average balance of the Bank's loans fell to $791.3 in 2002 from $815.1 for
last year and the average rate earned equaled 7.19% in 2002 compared to 8.38%
for 2001. The lower loan interest income also reflects the forfeiture of
$492,000 in accrued interest related to the December sale of indirect sub-prime
automobile loans. Interest and dividend income on the Company's investment
portfolio, including FHLB and SBLI stock, equaled $6.8 million in 2002, a
decrease of $330,000, or 4.7%, from $7.1 million earned in 2001. Higher average
balances were not enough to offset the decrease in average rate earned on the
investment portfolio. The average balance of the investment portfolio increased
$24.0 million to $168.7 million in 2002 while the average rate earned dropped 89
basis points to 4.01% in 2002.
The decrease in interest and dividend income was mostly offset by a
decrease in interest expense as interest paid dropped $10.1 million, or 30.2%,
to $23.4 million for the year ended December 31, 2002 from $33.6 million for the
year ended December 31, 2001 due to lower rates paid, particularly on the Bank's
deposit accounts. Interest paid on deposits totaled $17.8 million for the twelve
months ended December 31, 2002, a decrease of $8.9 million, or 33.4%, from $26.7
million for the twelve months ended December 31, 2001. Average interest bearing
deposit balances increased $21.7 million to $679.2 million in 2002 from $657.5
million in 2001, but were more than offset by a lower average rate paid of 2.62%
in 2002 compared to 4.06% in 2001. Interest paid on borrowings also decreased
due to lower interest rates paid as interest on FHLB advances and securities
sold under
- 38 -
agreements to repurchase totaled $5.7 million this year, a decrease of $1.2
million, or 17.8%, from $6.9 million last year, even though borrowings only
declined $2.2 million, or 1.6%, from last year.
Provision for Loan Losses. The provision for loan losses decreased $1.0
million, or 13.9%, to $6.2 million in 2002 from $7.2 million in 2001 as a
greater number of charge-offs in 2002 were more than offset by a higher number
of recoveries and a decrease in the balance of indirect sub-prime automobile
loans. Total charge-offs were $10.0 million in 2002, an increase of $3.0
million, or 42.0%, from $7.1 million last year. This increase was due to the
higher consumer loan charge-offs which rose $3.1 million in 2002. However, this
increase was somewhat offset by the Bank's strong efforts in 2002 to recover
charged-off loans. Recoveries totaled $3.1 million in 2002, an increase of $2.4
million over $705,000 in 2001. Net charge-offs were $6.9 million for the year
ended December 31, 2002 compared to $6.4 million last year, an increase of
$549,000, or 8.6%.
The provision for 2002 also includes $1.5 million added in the fourth
quarter of 2002 to cover losses inherent in the remaining indirect sub-prime
indirect automobile loan portfolio. At December 31, 2002, the allowance for loan
losses was $10.3 million and represented 1.43% of total loans and 275.54% of
nonperforming loans compared to $11.0 million at December 31, 2001, which
represented 1.37% of total loans and 408.36% of nonperforming loans.
Provisions for loan losses are charges to earnings to bring the total
allowance for loan losses to a level considered by management as adequate to
provide for estimated loan losses based on management's evaluation of the
collectibility of the loan portfolio. Management assesses the adequacy of the
allowance for loan losses based on known and inherent risks in the loan
portfolio and upon management's continuing analysis of the factors underlying
the quality of the loan portfolio. While management believes that, based on
information currently available, Berkshire Bank's allowance for loan losses is
sufficient to cover losses inherent in the Bank's loan portfolio at this time,
no assurances can be given that Berkshire Bank's level of allowance for loan
losses will be sufficient to cover future loan losses incurred by the Bank or
that future adjustments to the allowance for loan losses will not be necessary
if economic and other conditions differ substantially from the economic and
other conditions used by management to determine the current level of the
allowance for loan losses. Management may increase its level of allowance for
loan losses as a percentage of total loans and nonperforming loans if the level
of commercial real estate, multi-family, commercial, construction and
development or consumer loans as a percentage of its total loan portfolio
increases. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review Berkshire Bank's allowance for
loan losses. These agencies may require Berkshire Bank to provide additions to
the allowance based upon judgments different from management.
Noninterest Income. Noninterest income totaled $13.4 million for the
twelve months ended December 31, 2002, an increase of $2.9 million, or 27.2%,
over $10.6 million for 2001. Noninterest income for 2002 includes several items
related to the reorganizing of the Company's long-term business strategy that
took place in the fourth quarter of 2002. A $14.8 million gain on the sale of
equity securities was nearly offset by $13.4 million in charges relating to the
sale of indirect sub-prime automobile loans, the writedown of one security, the
writedown of repossessed automobiles, and the prepayment penalty on FHLB
advances. Noninterest income also increased in 2002 due to the recording of a
full year's worth of fees earned from the operations of EastPoint Technologies,
LLC versus only six months last year, a difference of $3.5 million. In addition,
customer service fees increased $423,000, or 23.4%, due to increased ATM and
checking account fees. Noninterest income for 2001 includes a one-time gain of
$2.2 million on the curtailment of the Bank's defined benefit pension plan.
Noninterest Expense. Noninterest (operating) expenses increased $13.5
million, or 41.6%, to $45.8 million for the year ended December 31, 2002 from
$32.3 million for the year ended December 31, 2001 as expenses for 2002 included
charges related to the restructuring of the Company's senior management and the
retirement of several directors. In the fourth quarter of 2002, the Company and
the Bank restructured their management team, which resulted in $6.6 million of
charges, consisting of the payment to or accrual of severance payments for three
executive officers and one senior vice president under existing contractual
obligations. Additionally, seven directors retired from the Boards of the
Company and the Bank and, as a result, the Company incurred a $300,000 charge in
the fourth quarter to fund retirement plan benefits. Expenses pertaining to
foreclosed real estate and other loans increased $1.0 million to $3.3 million as
the Bank wrote down the value of one commercial property by $500,000. As was the
case with noninterest income, noninterest expenses also increased due to the
recognition of a full year's worth of expenses of EastPoint compared to only six
months last year. The increase attributable to EastPoint totaled $4.8 million.
Income Taxes. Income taxes for the year ended December 31, 2002 were
$362,000, a decrease of $4.0 million from $4.3 million for the year ended
December 31, 2001. The effective tax rate for 2002 and 2001 were 17.0% and
32.8%, respectively. The lower rate paid in 2002 was due to the increase in the
ratio of tax exempt income and qualifying dividends received to pretax income.
Comparison of Operating Results for the Years Ended December 31, 2001 and 2000
Net Income. Net income rose $4.3 million, or 94.5%, to $8.9 million for
the year ended December 31, 2001 from $4.6 million for the year ended December
31, 2000. Net income for 2001 includes a one-time gain of $2.2 million from the
dissolution of the Bank's defined benefit pension plan while the results from
2000 include a $5.7 million donation of Berkshire Hills common stock by
Berkshire Hills to Berkshire Hills Foundation, in connection with the mutual to
stock conversion in June
- 39 -
2000. Basic and diluted earnings per share for the year ended December 31, 2001
were $1.42 and $1.35, respectively. There are no comparable earnings per share
figures for 2000, as the Company became a public company in June 2000.
Net Interest Income. Net interest income increased $4.7 million, or 12.5%,
to $42.2 million in 2001 from $37.5 million in 2000. A sustained decline in
market interest rates throughout 2001 coupled with a change in the Bank's
deposit pricing strategies helped to increase net interest income and kept
margins high. The Bank's net interest margin for the twelve months ended
December 31, 2001 and 2000 were 4.35% and 4.25%, respectively. Total interest
and dividend income rose $4.8 million, or 6.7%, to $75.8 million in 2001 from
$71.0 million in 2000 and was reduced by an increase in interest expense of only
$92,000 in 2001. Interest expense totaled $33.6 million in 2001 as compared to
$33.5 million in 2000 as increases in interest bearing liabilities were nearly
offset by lower rates paid.
The increase in interest income was due to an $87.9 million, or 9.9%,
increase in average interest earning assets which totaled $971.7 million this
year from $883.8 million last year. This increase more than offset a 24 basis
point decrease on average yield on interest earning assets which fell to 7.80%
in 2001 from 8.04% in 2000 as market rates began to have an adverse effect on
asset portfolio yields. Interest on loans rose $4.6 million, or 7.3%, to $68.3
million in 2001 from $63.7 million in 2000 fueled by the growth in commercial
real estate and construction loans, offset by a 15 basis point drop on average
yield on loans to 8.38% in 2001 from 8.53% in 2000. Investment securities
income, not including FHLB stock and SBLI stock, rose to $6.7 million in 2001
from $6.3 million in 2000, an increase of $429,000, or 6.8%, due to an increase
in average balances, offset by a decrease in average rate earned. The average
balance of investment securities increased $16.8 million to $136.9 million in
2001 while average yield on investment securities dropped 33 basis points to
4.91%.
Interest expense increased $92,000, or 0.3%, to $33.6 million in 2001 from
$33.5 million in 2000. Interest expense on deposits decreased $918,000, or 3.3%,
to $26.7 million in 2001 as the average cost of interest bearing deposits fell
to 4.06% in 2001 from 4.40% in 2000. This was somewhat offset by a $30.5 million
increase in average interest bearing deposit balances to $657.5 million in 2001
from $627.0 million in 2000 as people looked for a safe haven for their
investments. Interest paid on FHLB advances increased $847,000 to $6.6 million
as a 106 basis point drop in average cost could not offset a $35.4 million
increase in average FHLB balances. The average cost on FHLB borrowings was 5.17%
in 2001 versus 6.23% in 2000 while the average balance equaled $128.0 million in
2001 compared to $92.6 million in 2000. Interest paid on securities sold under
agreement to repurchase and other borrowings totaled $262,000 in 2001 as the
Bank realized $202,000 in interest expense early in the year to finance
automobile loans sold with recourse.
Provision for Loan Losses. The provision for loan losses increased $4.0
million, or 126.3%, to $7.2 million in 2001 from $3.2 million in 2000. The Bank
initiated a more aggressive charge-off policy for automobile loans whereby all
automobile loans that are 120 days or more past due, except customers who are in
bankruptcy proceedings, were charged-off. This change was the primary reason
total charge-offs increased to $7.1 million in 2001 from $1.9 million in 2000.
Additional provisions were also required to offset growth in the loan portfolio
and an increase in commercial loan delinquencies as a weakening economy
contributed to an increase in nonaccruing commercial loans to $2.1 million at
December 31, 2001 from $466,000 at December 31, 2000. Lastly, the Bank also
reviewed and updated its loan classifications and corresponding reserve
requirement percentages. As a result, the allowance for loan losses as a percent
of total loans increased to 1.37% in 2001 from 1.29% in 2000. The allowance for
loan losses as a percent of nonperforming loans was 408.36% this year from
356.08% last year.
Noninterest Income. Noninterest income totaled $10.5 million for 2001 and
$4.7 million for 2000, an increase of $5.8 million, or 122.3%. Noninterest
income for 2001 includes a one-time gain of $2.2 million related to the
curtailment of the Bank's defined benefit pension plan, and revenue of $3.5
million for license maintenance and processing fees, and license sales and other
fees that were derived from the operations of EastPoint Technologies, LLC which
was purchased in June of 2001. Excluding the pension plan gain and EastPoint's
revenues, noninterest income increased $164,000, or 3.5%, in 2001. Customer
service fees increased $220,000 to $1.8 million in 2001 as higher activity
levels resulted in increases in ATM fees, debit card fees, and bank service
charges. Loan servicing fees increased $149,000 to $595,000 in 2001 as the Bank
executed a strategy of selling newly written fixed rate loans.
Noninterest Expense. Noninterest expense increased $165,000, or 0.5%, to
$32.3 million for the year ended December 31, 2001 from $32.2 million last year.
Noninterest expense for 2001 included $3.4 million relating to EastPoint's
operations. Noninterest expense in 2000 included a contribution of $5.7 million
to fund Berkshire Hills Foundation. Excluding these two items, noninterest
expenses rose $2.5 million, or 9.3%, to $29.0 million in 2001 from $26.5 million
in 2000. Expenses related to foreclosed real estate and other loans, and in
particular, the repossession and sale of a larger number of automobiles,
accounted for an increase of $1.1 million, or 92.1%, to $2.2 million in 2001
from $1.2 million in 2000. Salaries and benefits increased to $17.6 million in
2001, up $4.0 million, or 29.0%, from $13.6 million in 2000 as the Company's
operating staff expanded due to the EastPoint purchase. Occupancy and equipment
expense was $4.7 million, an increase of $511,000, or 12.2%, from 2000 as the
Bank renovated two branches. Professional services increased $464,000, or 54.6%,
to $1.3 million in 2001 from $850,000 in 2000 primarily due to legal and
consulting expenses related to the acquisition and operation of EastPoint. Data
processing expense fell $700,000 as the Bank switched to an in-house imaging
system from an outsourced operation.
Income Taxes. Income taxes for the year ending December 31, 2001 were $4.3
million, an increase of $2.0 million, or 84.3%, over the $2.4 million paid for
the year ending December 31, 2000. The effective tax rates for 2001 and 2000
were 32.8% and 34.0%, respectively. The lower effective rate in 2001 was
partially attributable to the establishment of a real estate investment trust
through which the bank received state tax benefits.
- 40 -
Average Balances, Interest and Average Yields/Cost
The following table presents certain information for the years indicated
regarding average daily balances of assets and liabilities, as well as the total
dollar amounts of interest income from average interest-earning assets and
interest expense on average interest-bearing liabilities and the resulting
average yields and costs. The yields and costs for the years indicated are
derived by dividing income or expense by the average daily balances of assets or
liabilities, respectively, for the years presented. The yields and rates include
fees which are considered adjustments to yields.
For the Years Ended December 31,
---------------------------------------------
2002
---------------------------------------------
Average Average
Balance Interest Yield/Rate
------------- ------------- -------------
(Dollars in thousands)
Interest-earning assets:
Loans(1) $ 791,328 $ 56,910 7.19%
Short-term investments 27,870 456 1.64
Investment securities 159,318 6,416 4.03
Federal Home Loan Bank stock 7,303 283 3.88
Savings Bank Life Insurance
stock 2,043 63 3.08
Interest-earning deposits -- -- --
------------- ------------- -------------
Total interest-earning assets 987,862 64,128 6.49
Noninterest-earning assets 63,948
-------------
Total assets $ 1,051,810
=============
Interest-bearing liabilities:
Deposits:
Money market accounts $ 117,950 $ 1,988 1.69%
NOW accounts 83,399 623 0.75
Savings accounts(2) 157,444 2,669 1.70
Certificates of deposit 320,415 12,497 3.90
------------- -------------
Total interest-bearing deposits 679,208 17,777 2.62
Federal Home Loan Bank
advances 140,406 5,628 4.01
Repurchase agreements 1,349 23 1.72
------------- -------------
Total interest-bearing liabilities 820,963 23,428 2.85
-------------
Noninterest-bearing demand
deposits 82,751
Other noninterest-bearing
liabilities 11,935
-------------
Total liabilities 915,649
Equity 136,161
-------------
Total liabilities and equity $ 1,051,810
=============
Net interest-earning assets $ 166,899
=============
Net interest income $ 40,700
=============
Interest rate spread 3.64%
Interest margin (net interest
income as a percentage of
total average interest-earning
assets) 4.12%
Total average interest-earning
assets to total average
interest-bearing liabilities 120.33%
For the Years Ended December 31,
---------------------------------------------
2001
---------------------------------------------
Average Average
Balance Interest Yield/Rate
------------- ------------- -------------
(Dollars in thousands)
Interest-earning assets:
Loans(1) $ 815,078 $ 68,291 8.38%
Short-term investments 11,883 413 3.48
Investment securities 136,944 6,725 4.91
Federal Home Loan Bank stock 5,707 304 5.33
Savings Bank Life Insurance
stock 2,043 63 3.08
Interest-earning deposits -- -- --
------------- ------------- -------------
Total interest-earning assets 971,655 75,796 7.80
Noninterest-earning assets 63,207
-------------
Total assets $ 1,034,862
=============
Interest-bearing liabilities:
Deposits:
Money market accounts $ 112,434 $ 3,712 3.30%
NOW accounts 77,276 806 1.04
Savings accounts(2) 142,150 4,087 2.88
Certificates of deposit 325,639 18,080 5.55
------------- -------------
Total interest-bearing deposits 657,499 26,685 4.06
Federal Home Loan Bank
advances 127,990 6,613 5.17
Repurchase agreements 4,215 262 6.22
------------- -------------
Total interest-bearing liabilities 789,704 33,560 4.25
-------------
Noninterest-bearing demand
deposits 76,912
Other noninterest-bearing
liabilities 12,968
-------------
Total liabilities 879,584
Equity 155,278
-------------
Total liabilities and equity $ 1,034,862
=============
Net interest-earning assets $ 181,951
=============
Net interest income $ 42,236
=============
Interest rate spread 3.55%
Interest margin (net interest
income as a percentage of
total average interest-earning
assets) 4.35%
Total average interest-earning
assets to total average
interest-bearing liabilities 123.04%
For the Years Ended December 31,
---------------------------------------------
2000
---------------------------------------------
Average Average
Balance Interest Yield/Rate
------------- ------------- -------------
(Dollars in thousands)
Interest-earning assets:
Loans(1) $ 746,018 $ 63,664 8.53%
Short-term investments 10,492 654 6.23
Investment securities 120,123 6,296 5.24
Federal Home Loan Bank stock 4,959 333 6.72
Savings Bank Life Insurance
stock 2,043 63 3.08
Interest-earning deposits 127 8 6.30
------------- ------------- -------------
Total interest-earning assets 883,762 71,018 8.04
Noninterest-earning assets 52,891
-------------
Total assets $ 936,653
=============
Interest-bearing liabilities:
Deposits:
Money market accounts $ 106,058 $ 4,701 4.43%
NOW accounts 75,673 794 1.05
Savings accounts(2) 143,357 4,578 3.19
Certificates of deposit 301,920 17,530 5.81
------------- -------------
Total interest-bearing deposits 627,008 27,603 4.40
Federal Home Loan Bank
advances 92,567 5,766 6.23
Repurchase agreements 1,683 99 5.88
------------- -------------
Total interest-bearing liabilities 721,258 33,468 4.64
-------------
Noninterest-bearing demand
deposits 76,060
Other noninterest-bearing
liabilities 16,170
-------------
Total liabilities 813,488
Equity 123,165
-------------
Total liabilities and equity $ 936,653
=============
Net interest-earning assets $ 162,504
=============
Net interest income $ 37,550
=============
Interest rate spread 3.40%
Interest margin (net interest
income as a percentage of
total average interest-earning
assets) 4.25%
Total average interest-earning
assets to total average
interest-bearing liabilities 122.53%
- ----------
(1) Average balances include nonaccrual loans.
(2) Includes mortgagors' escrow accounts.
- 41 -
Rate/Volume Analysis
The following table presents the effects of changing rates and volumes on
the interest income and interest expense of Berkshire Bank. The rate column
shows the effects attributable to changes in rate (changes in rate multiplied by
prior volume). The volume column shows the effects attributable to changes in
volume (changes in volume multiplied by prior rate). The net column represents
the sum of the prior columns. For purposes of this table, changes attributable
to changes in both rate and volume, which cannot be segregated, have been
allocated proportionately based on the absolute value of the change due to rate
and the change due to volume.
Year Ended December 31, 2002 Year Ended December 31, 2001
Compared to Compared to
Year Ended December 31, 2001 Year Ended December 31, 2000
-------------------------------------- --------------------------------------
Increase (Decrease) Due to Increase (Decrease) Due to
-------------------------------------- --------------------------------------
Rate Volume Net Rate Volume Net
-------- -------- -------- -------- -------- --------
(In thousands)
Interest-earning assets:
Loans $ (9,440) $ (1,941) $(11,381) $ (1,133) $ 5,760 $ 4,627
Short-term investments (29) 72 43 (340) 99 (241)
Investment securities (3,668) 3,338 (330) (398) 798 400
Interest-bearing deposits -- -- -- (4) (4) (8)
-------- -------- -------- -------- -------- --------
Total interest-earning assets (13,137) 1,469 (11,668) (1,875) 6,653 4,778
-------- -------- -------- -------- -------- --------
Interest-bearing liabilities:
Deposits:
Money market accounts (1,915) 191 (1,724) (1,294) 305 (989)
NOW accounts (254) 71 (183) (5) 17 12
Savings accounts (1,922) 504 (1,418) (453) (38) (491)
Certificates of deposit (5,297) (286) (5,583) (691) 1,241 550
-------- -------- -------- -------- -------- --------
Total deposits (9,388) 480 (8,908) (2,443) 1,525 (918)
Federal Home Loan Bank
advances 751 (1,736) (985) (681) 1,528 847
Repurchase agreements (123) (116) (239) 6 157 163
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities (8,760) (1,372) (10,132) (3,118) 3,210 92
-------- -------- -------- -------- -------- --------
Increase (decrease) in net interest
income $ (4,377) $ 2,841 $ (1,536) $ 1,243 $ 3,443 $ 4,686
======== ======== ======== ======== ======== ========
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations
of a short-term nature. The Bank further defines liquidity as the ability to
respond to the needs of depositors and borrowers as well as maintaining the
flexibility to take advantage of investment opportunities. The Bank's primary
sources of funds consist of deposit inflows, loan repayments, maturities,
paydowns of mortgage-backed securities, sales/calls of investments and
borrowings from the Federal Home Loan Bank of Boston. While maturities and
scheduled amortization of loans and securities are predictable sources of funds,
deposit outflows and mortgage prepayments are greatly influenced by general
interest rates, economic conditions and competition.
The Bank's primary investing activities are: (1) originating residential
one-to four-family mortgage loans, commercial business and real estate loans,
multi-family loans, home equity lines of credit and consumer loans, and (2)
investing in mortgage- and asset-backed securities, U.S. Government and agency
obligations, corporate bonds and, to a lesser extent, equity securities. These
activities are funded primarily by principal and interest payments on loans,
maturities of securities, deposits and Federal Home Loan Bank of Boston
advances. During the years ended December 31, 2002 and 2001, Berkshire Bank's
loan originations totaled $285.9 million and $252.9 million, respectively. At
December 31, 2002 and 2001, the Bank's investments in mortgage- and asset-backed
securities, U.S. Government and Agency obligations, equity securities and
corporate debt obligations totaled $226.9 million and $146.8 million,
respectively. The Bank experienced a net increase in total deposits of $39.6
million and $13.1 million for the years ended December 31, 2002 and 2001,
respectively. Deposit flows are affected by the overall level of interest rates,
the interest rates and products offered by the Bank and its local competitors
and other factors. The Bank closely monitors its liquidity position on a daily
basis. If the Bank should require funds beyond its ability to generate them
internally, additional sources of funds are available through advances or a line
of credit with the Federal Home Loan Bank and through a repurchase agreement
with the Depositors Insurance Fund.
- 42 -
Outstanding commitments for all loans and unadvanced construction loans
and lines of credit totaled $142.4 million at December 31, 2002. Management of
Berkshire Bank anticipates that it will have sufficient funds available to meet
its current loan commitments. Certificates of deposit that are scheduled to
mature in one year or less from December 31, 2002 totaled $215.2 million. The
Bank relies primarily on competitive rates, customer service, and long-standing
relationships with customers to retain deposits. Occasionally, the Bank will
also offer special competitive promotions to its customers to increase retention
and promote deposit growth. Based upon the Bank's historical experience with
deposit retention, management believes that, although it is not possible to
predict future terms and conditions upon renewal, a significant portion of such
deposits will remain with the Bank.
The Bank must satisfy various regulatory capital requirements administered
by the federal and state banking agencies including a risk-based capital
measure. The risk-based capital guidelines include both a definition of capital
and a framework for calculating risk-weighted assets by assigning balance sheet
assets and off-balance sheet items to broad risk categories. At December 31,
2002, Berkshire Bank exceeded all of its regulatory capital requirements with
Tier 1 capital to average assets of $90.8 million, or 8.78% of average assets,
which is above the required level of $41.4 million, or 4.0%, and total capital
to risk-weighted assets of $104.3 million, or 13.55% of risk-weighted assets,
which is above the required level of $61.5 million, or 8.0%. The Bank meets the
conditions to be considered "well capitalized" under regulatory guidelines.
The primary source of funding for Berkshire Hills is dividend payments
from Berkshire Bank, sales and maturities of investment securities and, to a
lesser extent, earnings on investments and deposits held by Berkshire Hills.
Dividend payments by Berkshire Bank have primarily been used to fund stock
repurchase programs and pay dividends to Berkshire Hills' shareholders. The
Bank's ability to pay dividends and other capital distributions to Berkshire
Hills is generally limited by the Massachusetts banking regulations and
regulations of the Federal Deposit Insurance Corporation. (See "Regulation and
Supervision - Massachusetts Regulation") Additionally, the Massachusetts
Commissioner of Banks and Federal Deposit Insurance Corporation may prohibit the
payment of dividends which are otherwise permissible by regulation for safety
and soundness reasons. Any dividend by the Bank beyond its current year's
earnings and prior two years' retained net income would require the approval of
the Massachusetts Commissioner of Banks, and notification to or approval of the
Federal Deposit Insurance Corporation and the Office of Thrift Supervision. To
the extent the Bank were to apply for a dividend distribution to Berkshire Hills
in excess of the regulatory permitted dividend amount, no assurances can be made
such application would be approved by the regulatory authorities.
Berkshire Hills is currently engaged in its fifth 5% stock repurchase
program. To date, all purchases have been open market purchases. In the current
program, 140,100 shares out of an announced 312,516 have been purchased at a
cost of $3.2 million through December 31, 2002. The Company has sufficient funds
available to complete the repurchase program without having a material adverse
effect on liquidity.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented in this
Form 10-K have been prepared in conformity with accounting principles generally
accepted in the United States of America, which require the measurement of
financial position and operating results in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation. Unlike many industrial companies, substantially all of the assets and
liabilities of Berkshire Bank are monetary in nature. As a result, interest
rates have a more significant impact on Berkshire Bank's performance than the
general level of inflation. Over short periods of time, interest rates may not
necessarily move in the same direction or in the same magnitude as inflation.
Impact of New Accounting Standards
Accounting for Goodwill and Other Intangible Assets. The Company adopted
SFAS No. 142, "Goodwill and Other Intangible Assets," effective January 1, 2002.
Accordingly, goodwill is no longer subject to amortization over its estimated
useful life, but is subject to at least an annual assessment for impairment by
applying a fair value based test. Additionally, under SFAS No. 142, acquired
intangible assets (such as core deposit intangibles) are separately recognized
if the benefit of the intangible asset is obtained through contractual or other
legal rights, or if the intangible asset can be sold, transferred, licensed,
rented, or exchanged, and amortized over their useful life. Branch acquisition
transactions were outside the scope of SFAS No. 142 and, accordingly, intangible
assets related to such transactions continued to amortize upon the adoption of
SFAS No. 142. On October 31, 2002, the Company adopted SFAS No. 147,
"Acquisitions of Certain Financial Institutions." This Statement amends (except
for transactions between two or more mutual enterprises) previous interpretive
guidance on the application of the purchase method of accounting to acquisitions
of financial institutions, and requires the application of SFAS No. 141,
"Business Combinations" and SFAS No. 142 to branch acquisitions if such
transactions meet the definition of a business combination. This Statement
amends SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", to include in its scope core deposit intangibles of financial
institutions. Accordingly, such intangibles are subject to a recoverability test
based on undiscounted cash flows, and to the impairment recognition and
measurement provisions that are required for other long-lived assets that are
held and used.
- 43 -
The adoption of these statements did not have a material impact on the
Company's consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Management of Interest Rate Risk and Market Risk Analysis
Qualitative Aspects of Market Risk. The Bank's most significant form of
market risk is interest rate risk. The principal objectives of Berkshire Bank's
interest rate risk management are to evaluate the interest rate risk inherent in
certain balance sheet accounts, determine the level of risk appropriate given
its business strategy, operating environment, capital and liquidity requirements
and performance objectives, and manage the risk consistent with its established
policies. Berkshire Bank maintains an Asset/Liability Committee that is
responsible for reviewing its asset/liability policies and interest rate risk
position, which meets quarterly and reports trends and interest rate risk
position to the Executive Committee of the Board of Directors and the Board of
Directors on a quarterly basis. The Asset/Liability Committee consists of
Berkshire Bank's President and Chief Executive Officer, Senior Vice President
and Chief Financial Officer, Senior Vice President-Retail Banking and
Operations, Senior Vice President -Retail Lending, Senior Vice President
Commercial Lending, Vice President and Controller, and Vice President of Trust.
The extent of the movement of interest rates is an uncertainty that could have a
negative impact on the earnings of Berkshire Bank.
In recent years, Berkshire Bank has managed interest rate risk by:
o emphasizing the origination of adjustable-rate loans and, from time
to time, selling a portion of its longer term fixed-rate loans as
market interest rate conditions dictate;
o originating shorter-term commercial and consumer loans;
o investing in a high quality liquid securities portfolio that
provides adequate liquidity and flexibility to take advantage of
opportunities that may arise from fluctuations in market interest
rates, the overall maturity and duration of which is monitored in
relation to the repricing of its loan portfolio;
o promoting lower cost liability accounts such as core deposits; and
o using Federal Home Loan Bank advances to better structure maturities
of its interest rate sensitive liabilities.
Berkshire Bank's market risk also includes equity price risk. Berkshire
Bank's marketable equity securities portfolio had gross unrealized gains of $8.5
million at December 31, 2002 and gross unrealized losses of $77,000 which are
included, net of taxes, in accumulated other comprehensive income, a separate
component of Berkshire Bank's equity. If equity securities prices decline due to
unfavorable market conditions or other factors, Berkshire Bank's and Berkshire
Hills' capital would decrease.
Quantitative Aspects of Market Risk. Berkshire Hills uses a simulation
model to measure the potential change in net interest income, incorporating
various assumptions regarding the shape of the yield curve, the pricing
characteristics of loans, deposits and borrowings, prepayments on loans and
securities and changes in the balance sheet mix. The model assumes the yield
curve is derived from the interpolated Treasury yield curve and that an
instantaneous increase or decrease of market interest rates would cause a
simultaneous parallel shift along the entire yield curve. Loans, deposits and
borrowings are expected to reprice at the new market rate on the contractual
review or maturity date. The Company closely monitors its loan prepayment trends
and uses prepayment guidelines set forth by Freddie Mac and Fannie Mae as well
as Company generated figures where applicable. All prepayments are assumed to
roll over into new loans originated in the same loan category at the new market
rate. Berkshire Hills further assumes that its securities' cash flows,
especially its mortgage backed securities cash flows, are such that they will
generally follow industry standards and that prepayments will be reinvested in
the same category at the prevailing market rate. Finally, the model assumes that
its balance sheet mix will remain relatively unchanged throughout the next
calendar year.
- 44 -
The tables below set forth, as of December 31, 2002 and 2001, estimated
net interest income and the estimated changes in Berkshire Hills' net interest
income for the next twelve month period which may result given instantaneous
increases or decreases in market interest rates of 100 and 200 basis points.
Increase/(Decrease) in At December 31, 2002
Market Interest Rates in -------------------------------------------------------
Basis Points (Rate Shock) Amount $ Change % Change
- ------------------------- ------- -------- --------
(Dollars in thousands)
200 $34,583 $(1,027) (2.88%)
100 34,741 (869) (2.44)
Static 35,610 -- --
(100) 35,162 (448) (1.26)
(200) 32,908 (2,702) (7.59)
Increase/(Decrease) in At December 31, 2001
Market Interest Rates in -------------------------------------------------------
Basis Points (Rate Shock) Amount $ Change % Change
- ------------------------- ------- -------- --------
(Dollars in thousands)
200 $45,863 $ 64 0.14%
100 45,209 (590) (1.29)
Static 45,799 -- --
(100) 46,332 533 1.16
(200) 44,955 (844) (1.84)
The December 31, 2002 table indicates that in the event of a sudden and
sustained decline in prevailing market interest rates of 100 basis points and
200 basis points, Berkshire Hills' net interest income would be expected to
decrease by $448,000 and $2.7 million, respectively. The primary reasons for the
decreases in a declining interest rate environment are that interest rate floors
on deposit accounts would be reached and that the Company has a high level of
option risk, including the risk that customers will prepay high rate loans.
These figures vary from the results of the December 31, 2001 table that
indicates in the event of a sudden and sustained decline of 100 basis points,
Berkshire Hills' net interest income would be expected to increase $533,000 and
in the event of a 200 basis point decline, net interest income would be expected
to decrease $844,000. The primary reason for this difference is that in 2002
many deposit accounts had reached or had come close to reaching Company
determined floors, while in 2001 for a 100 basis point decline in rates the
accounts had not yet reached these floors and the Company benefited from being
liability sensitive.
In the event of a sudden and sustained increase in prevailing market
interest rates of 100 and 200 basis points, the 2002 table indicates that net
interest income would decrease $869,000 and $1.0 million, respectively. This
result is due to the fact that the Company's balance sheet is liability
sensitive and predetermined caps on various deposit accounts would not be
reached. This compares to the 2001 table that indicates in the event of an
increase of 100 basis points, net interest income would decrease $590,000 and in
the event of an increase of 200 basis points, net interest income would increase
$64,000. The difference in the positive 200 basis point scenario is that the
2001 table indicates that the Company's deposit accounts would have reached
Company determined caps, while in the 2002 table the deposit accounts are just
approaching these caps.
Computation of prospective effects of hypothetical interest rate changes
are based on a number of assumptions including the level of market interest
rates, the degree to which certain assets and liabilities with similar
maturities or periods to repricing react to changes in market interest rates,
the expected prepayment rates on loans and investments, the degree to which
early withdrawals occur on certificates of deposit and other deposit flows. As a
result, these computations should not be relied upon as indicative of actual
results. Further, the computations do not reflect any actions that management
may undertake in response to changes in interest rates.
- 45 -
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
TABLE OF CONTENTS
Page
Independent Auditors' Report 47
Consolidated Balance Sheets as of December 31, 2002
and 2001 48
Consolidated Statements of Income for the Years Ended
December 31, 2002, 2001 and 2000 49
Consolidated Statements of Changes in Stockholders'
Equity for the Years Ended December 31, 2002,
2001 and 2000 50
Consolidated Statements of Cash Flows for the Years
Ended December 31, 2002, 2001 and 2000 51 - 52
Notes to Consolidated Financial Statements 53 - 96
- 46 -
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Berkshire Hills Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Berkshire Hills
Bancorp, Inc. and subsidiaries as of December 31, 2002 and 2001, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 2002.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Berkshire Hills
Bancorp, Inc. and subsidiaries as of December 31, 2002 and 2001 and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2002 in conformity with accounting principles
generally accepted in the United States of America.
/s/ Wolf & Company, P.C.
- ------------------------
Boston, Massachusetts
January 21, 2003, except as to Note 23, which
is as of March 5, 2003
- 47 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
ASSETS
2002 2001
----------- -----------
(In thousands)
Cash and due from banks $ 17,258 $ 22,652
Short-term investments 43,397 19,471
----------- -----------
Total cash and cash equivalents 60,655 42,123
Securities available for sale, at fair value 173,169 104,446
Securities held to maturity (fair value approximates $44,348,000 and
$33,409,000 at December 31, 2002 and 2001, respectively) 44,267 33,263
Federal Home Loan Bank stock, at cost 7,440 7,027
Loans, net of allowance for loan losses of $10,308,000
in 2002 and $11,034,000 in 2001 712,714 791,920
Foreclosed real estate, net 1,500 --
Premises and equipment, net 13,267 14,213
Accrued interest receivable 5,125 5,873
Savings Bank Life Insurance stock 2,043 2,043
Goodwill and other intangibles 9,938 10,592
Net deferred tax asset 2,185 --
Other assets 13,315 19,201
----------- -----------
$ 1,045,618 $ 1,030,701
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 782,360 $ 742,729
Federal Home Loan Bank advances 133,002 133,964
Loans sold with recourse 1,201 --
Securities sold under agreements to repurchase 700 1,890
Net deferred tax liability -- 4,573
Accrued expenses and other liabilities 5,677 5,099
----------- -----------
Total liabilities 922,940 888,255
----------- -----------
Minority Interests 2,438 3,123
----------- -----------
Commitments and contingencies (Notes 6, 13 and 14)
Stockholders' equity:
Preferred stock ($.01 par value; 1,000,000 shares
authorized; no shares issued and outstanding) -- --
Common stock ($.01 par value; 26,000,000 shares authorized;
and 6,425,140 shares issued at December 31, 2002 and
2001, respectively) 77 77
Additional paid-in capital 74,632 74,146
Unearned compensation (9,535) (11,101)
Retained earnings 79,682 80,657
Accumulated other comprehensive income 5,542 18,836
Treasury stock, at cost (1,556,627 and 1,248,621 shares
at December 31, 2002 and 2001, respectively) (30,158) (23,292)
----------- -----------
Total stockholders' equity 120,240 139,323
----------- -----------
Total liabilities and stockholders' equity $ 1,045,618 $ 1,030,701
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
- 48 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
-------- -------- --------
(In thousands, except per share data)
Interest and dividend income:
Loans, including fees $ 56,910 $ 68,291 $ 63,664
Debt securities:
Taxable 5,234 5,233 5,142
Tax-exempt 173 375 188
Dividends 1,355 1,484 1,362
Short-term and other investments 456 413 662
-------- -------- --------
Total interest and dividend income 64,128 75,796 71,018
-------- -------- --------
Interest expense:
Deposits 17,777 26,685 27,603
Federal Home Loan Bank advances 5,628 6,613 5,766
Securities sold under agreements to repurchase 23 262 99
-------- -------- --------
Total interest expense 23,428 33,560 33,468
-------- -------- --------
Net interest income 40,700 42,236 37,550
Provision for loan losses 6,180 7,175 3,170
-------- -------- --------
Net interest income, after provision for loan losses 34,520 35,061 34,380
-------- -------- --------
Other income:
Customer service fees 2,233 1,810 1,590
Trust department fees 1,796 1,782 1,707
Loan servicing fees 440 595 446
Gain on sales and dispositions of securities, net 15,143 268 423
Loss on impairment of securities (673) -- --
Loss on sale of loans, net (10,702) -- --
Loss on impairment of other assets (1,262) -- --
Penalty on prepayment of FHLB borrowings (1,067) -- --
License maintenance and processing fees 4,379 1,322 --
License sales and other fees 2,612 2,143 --
Gain on curtailment of defined benefit pension plan, net -- 2,173 --
Miscellaneous 519 455 580
-------- -------- --------
Total other income 13,418 10,548 4,746
-------- -------- --------
Operating expenses:
Salaries and employee benefits 28,488 17,590 13,631
Occupancy and equipment 5,288 4,689 4,178
Marketing and advertising 648 629 578
Data processing 758 1,065 1,765
Professional services 1,384 1,314 850
Office supplies 769 899 706
Foreclosed real estate and repossessed assets, net 3,250 2,238 1,165
Amortization of goodwill and other intangibles 654 827 549
Charitable contribution to foundation -- -- 5,684
Minority interests (685) (119) --
Other general and administrative expenses 5,253 3,217 3,078
-------- -------- --------
Total operating expenses 45,807 32,349 32,184
-------- -------- --------
Income before income taxes 2,131 13,260 6,942
Provision for income taxes 362 4,349 2,360
-------- -------- --------
Net income $ 1,769 $ 8,911 $ 4,582
======== ======== ========
Earnings per share:
Basic $ 0.33 $ 1.42 N/A
Diluted $ 0.30 $ 1.35 N/A
The accompanying notes are an integral part of these consolidated financial
statements.
- 49 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2002, 2001 and 2000
Additional
Common Paid-in Unearned Retained
Stock Capital Compensation Earnings
--------- --------- --------- ---------
(In thousands)
Balance at December 31, 1999 $ -- $ -- $ -- $ 70,679
Comprehensive income:
Net income -- -- -- 4,582
Change in net unrealized gain on
securities available for sale, net
of reclassification adjustment and
tax effects -- -- -- --
Total comprehensive income
Issuance of common stock in connection
with Bank's conversion from mutual to
stock-owned bank holding company 77 73,993 (7,701) --
Change in unearned compensation -- 61 514 --
Cash dividends paid ($0.10 per share) -- -- -- (707)
--------- --------- --------- ---------
Balance at December 31, 2000 77 74,054 (7,187) 74,554
Comprehensive income:
Net income -- -- -- 8,911
Change in net unrealized gain on
securities available for sale, net
of reclassification adjustment and
tax effects -- -- -- --
Total comprehensive income
Cash dividends paid ($0.43 per share) -- -- -- (2,808)
Treasury stock purchased -- -- -- --
Purchase of common stock - stock awards -- -- (5,453) --
Change in unearned compensation -- 234 1,539 --
Minority interest adjustment -- (142) -- --
--------- --------- --------- ---------
Balance at December 31, 2001 77 74,146 (11,101) 80,657
Comprehensive income (loss):
Net income -- -- -- 1,769
Change in net unrealized gain on
securities available for sale, net
of reclassification adjustment and
tax effects -- -- -- --
Total comprehensive loss
Cash dividends paid ($0.48 per share) -- -- -- (2,737)
Treasury stock purchased -- -- -- --
Reissuance of treasury stock under stock
option plan (6,907 shares) -- -- -- (7)
Change in unearned compensation -- 486 1,566 --
--------- --------- --------- ---------
Balance at December 31, 2002 $ 77 $ 74,632 $ (9,535) $ 79,682
========= ========= ========= =========
Accumulated
Other
Comprehensive Treasury
Income Stock Total
--------- --------- ---------
(In thousands)
Balance at December 31, 1999 $ 17,673 $ -- $ 88,352
---------
Comprehensive income:
Net income -- -- 4,582
Change in net unrealized gain on
securities available for sale, net
of reclassification adjustment and
tax effects 2,151 -- 2,151
---------
Total comprehensive income 6,733
---------
Issuance of common stock in connection
with Bank's conversion from mutual to
stock-owned bank holding company -- -- 66,369
Change in unearned compensation -- -- 575
Cash dividends paid ($0.10 per share) -- -- (707)
--------- --------- ---------
Balance at December 31, 2000 19,824 -- $ 161,322
---------
Comprehensive income:
Net income -- -- 8,911
Change in net unrealized gain on
securities available for sale, net
of reclassification adjustment and
tax effects (988) -- (988)
---------
Total comprehensive income 7,923
---------
Cash dividends paid ($0.43 per share) -- -- (2,808)
Treasury stock purchased -- (23,292) (23,292)
Purchase of common stock - stock awards -- -- (5,453)
Change in unearned compensation -- -- 1,773
Minority interest adjustment -- -- (142)
--------- --------- ---------
Balance at December 31, 2001 18,836 (23,292) 139,323
---------
Comprehensive income (loss):
Net income -- -- 1,769
Change in net unrealized gain on
securities available for sale, net
of reclassification adjustment and
tax effects (13,294) -- (13,294)
---------
Total comprehensive loss (11,525)
---------
Cash dividends paid ($0.48 per share) -- -- (2,737)
Treasury stock purchased -- (6,989) (6,989)
Reissuance of treasury stock under stock
option plan (6,907 shares) -- 123 116
Change in unearned compensation -- -- 2,052
--------- --------- ---------
Balance at December 31, 2002 $ 5,542 $ (30,158) $ 120,240
========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
- 50 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
--------- --------- ---------
(In thousands)
Cash flows from operating activities:
Net income $ 1,769 $ 8,911 $ 4,582
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 6,180 7,175 3,170
Net amortizaton of securities 1,103 270 206
Charitable contribution in the form of equity
securities -- -- 5,684
Depreciation and amortization expense 2,414 2,081 1,668
Amortization of goodwill and other intangibles 654 827 549
Management rewards plan expense 1,165 1,000 --
Employee stock ownership plan expense 887 773 575
Gain on curtailment of defined benefit pension plan, net -- 2,173 --
Gain on sales and dispositions of securities, net (15,143) (268) (423)
Loss on impairment of securities 673 -- --
Loss on sale/writedown of foreclosed real estate, net 500 -- 86
Loss on impairements of other assets 1,262 -- --
Loss on sale of equipment -- 35 18
Loss on sale of loans 10,702 -- --
Deferred income tax provision (benefit) (431) 608 (2,785)
Net change in loans held for sale 2,540 (2,540) --
Undistributed minority interest (685) (119) --
Changes in operating assets and liabilities:
Accrued interest receivable and other assets 5,372 1,899 (9,491)
Accrued expenses and other liabilities 578 (2,929) (1,625)
--------- --------- ---------
Net cash provided by operating activities 19,540 19,896 2,214
--------- --------- ---------
Cash flows from investing activities:
Activity in available-for-sale securities:
Sales 28,255 3,965 32,854
Maturities 68,232 26,577 41,238
Principal payments 30,096 19,685 10,263
Purchases (201,258) (56,890) (87,029)
Activity in held-to-maturity securities:
Maturities 16,374 12,982 11,076
Principal payments 29,132 22,187 11,294
Purchases (56,812) (36,175) (37,583)
Purchase of FHLB stock (413) (1,376) (1,808)
Loan originations and purchases, net of
principal payments (8,616) (13,176) (121,101)
Additions to premises and equipment (1,468) (2,344) (2,528)
(continued)
The accompanying notes are an integral part of these consolidated financial
statements.
- 51 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Concluded)
Years Ended December 31, 2002, 2001 and 2000
2002 2001 2000
--------- --------- ---------
(In thousands)
Proceeds from sales of loans 66,400 -- --
Proceeds from sales of foreclosed real estate -- 76 164
Proceeds from sale of equipment -- 20 3
Loan to fund employee stock ownership plan -- -- (7,701)
Payment for purchase of EastPoint Technologies, LLC -- (4,700) --
--------- --------- ---------
Net cash used in investing activities (30,078) (29,169) (150,858)
--------- --------- ---------
Cash flows from financing activities:
Net increase in deposits 39,631 14,638 48,827
Net (decrease) increase in securities sold under
agreements to repurchase (1,190) (140) 910
Proceeds from Federal Home Loan Bank advances 120,172 152,000 140,000
Repayments of Federal Home Loan Bank advances (121,134) (119,421) (97,542)
Increase (decrease) in loans sold with recourse 1,201 (7,740) 7,740
Treasury stock purchased (6,989) (23,292) --
Proceeds from reissuance of treasury stock 116 -- --
Purchase of common stock in connection with restricted
stock awards under stock based incentive plan -- (5,453) --
Net proceeds from initial public offering -- -- 68,386
Cash dividends paid (2,737) (2,808) (707)
--------- --------- ---------
Net cash provided by financing activities 29,070 7,784 167,614
--------- --------- ---------
Net change in cash and cash equivalents 18,532 (1,489) 18,970
Cash and cash equivalents at beginning of year 42,123 43,612 24,642
--------- --------- ---------
Cash and cash equivalents at end of year $ 60,655 $ 42,123 $ 43,612
========= ========= =========
Supplemental cash flow information:
Interest paid on deposits $ 17,835 $ 26,746 $ 27,603
Interest paid on borrowed funds 6,856 6,719 5,610
Income taxes paid, net 3,019 2,882 6,314
Transfers from loans to foreclosed real estate 2,000 26 80
The accompanying notes are an integral part of these consolidated financial
statements.
- 52-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2002, 2001 and 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation and consolidation
Berkshire Hills Bancorp, Inc. (the "Company") is a Delaware corporation and the
holding company for Berkshire Bank (the "Bank"), a state-chartered savings bank
headquartered in Pittsfield, Massachusetts. These consolidated financial
statements include the accounts of Berkshire Hills Bancorp, Inc. and its
wholly-owned subsidiaries, Berkshire Bank, Berkshire Hills Funding Corporation,
and Berkshire Hills Technology, Inc., which was formed during 2001 for the
purpose of acquiring a controlling interest in EastPoint Technologies, LLC. The
Bank's wholly-owned subsidiaries are North Street Securities Corporation, Gold
Leaf Insurance Company, Gold Leaf Investment Services, and Woodland Securities
Corporation, Inc. North Street Securities Corporation and Woodland Securities
Corporation, Inc. hold title to certain investment securities. Gold Leaf
Insurance Company and Gold Leaf Investment Services were formed in 2000 and
offer insurance and investment products to customers. Berkshire Hills Funding
Corporation was established and funded to loan funds to the Bank's Employee
Stock Ownership Plan. During 2001, the Bank established a majority owned
subsidiary, Gold Leaf Capital Corporation, which holds real estate mortgages.
All significant intercompany balances and transactions have been eliminated in
consolidation.
On June 29, 2001, the Company, through its wholly-owned subsidiary, Berkshire
Hills Technology, Inc., purchased a controlling interest in EastPoint
Technologies, LLC, ("EastPoint") which on the same date acquired all of the
domestic operations and service contracts of M&I EastPoint Technology, Inc,
Bedford, New Hampshire, a software and data processing provider for financial
institutions, as well as substantially all of the operations and service
contracts of Preferred Financial Systems, Inc., Arden Hills, Minnesota, a data
processing service provider which utilized the EastPoint Technology, Inc.
software. The Company's equity interest in EastPoint at December 31, 2002 and
2001 is 60.3% and represents a total investment of $4.7 million. During 2001 the
Company's ownership percentage decreased from 93.6% to 60.3% as other investor
financial institutions obtained regulatory approval to invest in EastPoint
Technologies, LLC. The change in ownership percentage is shown as an adjustment
to additional paid-in capital. This acquisition was accounted for under the
purchase method of accounting.
On June 27, 2000, Berkshire Hills Bancorp, Inc. acquired the Bank. Prior to that
time, Berkshire Bancorp existed as a mutual holding company and owned all of the
outstanding capital stock of Berkshire Bank. After the conversion on June 27,
2000, Berkshire Bancorp ceased to exist. In connection with the conversion, the
Company issued an aggregate of 7,673,761 shares of its common stock of which
7,105,334 shares were sold at a purchase price of $10 per share at that time,
and 568,427 shares of stock were donated to Berkshire Hills Foundation, a
charitable foundation established by the Company. The net proceeds, after
offering expenses of $2.6 million, resulting from the offering totaled $68.4
million.
- 53 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Business
The Company provides a variety of financial services to individuals,
municipalities and businesses through its offices in Berkshire County. Its
primary deposit products are savings, checking accounts and term certificate
accounts and its primary lending products are residential and commercial
mortgage loans, commercial loans and automobile loans. In addition, trust
services and insurance products are offered to individuals and small businesses
in the Berkshire County area.
Use of estimates
In preparing consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the date of the consolidated balance sheet and
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses and deferred taxes.
Reclassifications
Certain amounts in the 2001 and 2000 consolidated financial statements have been
reclassified to conform to the 2002 presentation.
Cash and cash equivalents
For purposes of the consolidated statements of cash flows, cash and cash
equivalents include cash, balances due from banks and short-term investments,
all of which mature within ninety days.
Short-term investments
Short-term investments mature within ninety days and are carried at cost, which
approximates fair value.
Securities
Debt securities that management has the positive intent and ability to hold to
maturity are classified as "held to maturity" and recorded at amortized cost.
Securities not classified as held to maturity, including equity securities with
readily determinable fair values, are classified as "available for sale" and
recorded at fair value, with unrealized gains and losses excluded from earnings
and reported in other comprehensive income.
- 54 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Securities (concluded)
Purchase premiums and discounts are recognized in interest income using the
interest method over the terms of the securities. Declines in the fair value of
held-to-maturity and available-for-sale securities below their cost that are
deemed to be other than temporary are reflected in earnings as realized losses.
In estimating other-than-temporary impairment losses, management considers
independent price quotations and the financial condition of the issuer. Gains
and losses on the sale of securities are recorded on the trade date and are
determined using the specific identification method.
Federal Home Loan Bank of Boston ("FHLB") stock is reflected at cost. Savings
Bank Life Insurance Company of Massachusetts ("SBLI") stock was recorded at fair
value at acquisition as determined by an appraisal performed by independent
investment consultants retained by SBLI.
Loans
The Bank grants mortgage, commercial and consumer loans to customers. A
substantial portion of the loan portfolio is represented by mortgage loans in
Berkshire County. The ability of the Bank's debtors to honor their contracts is
dependent upon the local economy and the local real estate market.
Loans that management has the intent and ability to hold for the foreseeable
future or until maturity or pay-off generally are reported at their outstanding
unpaid principal balances adjusted for charge-offs, the allowance for loan
losses, and any deferred fees or costs on originated loans. Interest income is
accrued on the unpaid principal balance. Loan origination fees, net of certain
direct origination costs, are deferred and recognized as an adjustment of the
related loan yield using the interest method.
Interest on loans, excluding automobile loans, is generally not accrued on loans
which are ninety days or more past due unless the loan is well secured and in
the process of collection. Past due status is based on contractual terms of the
loan. Automobile loans continue accruing to one hundred and twenty days
delinquent at which time they are charged off, unless the customer is in
bankruptcy proceedings. All interest accrued but not collected for loans that
are placed on non-accrual or charged off is reversed against interest income.
The interest on these loans is accounted for on the cash-basis or cost-recovery
method, until qualifying for return to accrual. Loans are returned to accrual
status when all the principal and interest amounts contractually due are brought
current and future payments are reasonably assured.
- 55 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Loans (concluded)
A loan is considered impaired when, based on current information and events, it
is probable that a creditor will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Impaired loans are generally maintained on a non-accrual basis.
Impairment is measured on a loan by loan basis by either the present value of
expected future cash flows discounted at the loan's effective interest rate, or
the fair value of the collateral if the loan is collateral dependent.
Substantially all of the Bank's loans which have been identified as impaired
have been measured by the fair value of existing collateral.
Large groups of smaller balance homogeneous loans are collectively evaluated for
impairment. Accordingly, the Company does not separately identify individual
consumer loans or residential mortgage loans for impairment disclosures.
Allowance for loan losses
The allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loan losses
are charged against the allowance when management believes the uncollectibility
of a loan balance is confirmed. Subsequent recoveries, if any, are credited to
the allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The
specific component relates to loans that are classified as either doubtful,
substandard or special mention. For such loans that are also classified as
impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market price) of the impaired loan is lower than
the carrying value of that loan. The general component covers non-classified
loans and is based on historical loss experience adjusted for qualitative
factors. An unallocated component is maintained to cover uncertainties that
could affect management's estimate of probable losses. The unallocated component
of the allowance reflects the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating allocated and general
losses in the portfolio.
- 56 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Loans held for sale
Loans originated and intended for sale in the secondary market are carried at
the lower of cost or estimated fair value in the aggregate. Net unrealized
losses, if any, are recognized through a valuation allowance by charges to
income.
Foreclosed and repossessed assets
Assets acquired through, or in lieu of, loan foreclosure or repossession are
held for sale and are initially recorded at the lower of the investment in the
loan or fair value less estimated cost to sell at the date of foreclosure or
repossession, establishing a new cost basis. Subsequently, valuations are
periodically performed by management and the assets are carried at the lower of
carrying amount or fair value less cost to sell. Revenue and expenses from
operations and changes in the valuation allowance are included in net expenses
from foreclosed real estate and repossessed assets.
Premises and equipment
Land is carried at cost. Buildings and improvements and equipment are carried at
cost, less accumulated depreciation and amortization computed on the
straight-line method over the estimated useful lives of the assets or terms of
the leases, if shorter.
Goodwill and other intangibles
Goodwill and other intangibles includes goodwill associated with the acquisition
of EastPoint which is evaluated for impairment on an annual basis. Intangible
assets refer to customer relationships acquired in association with the
EastPoint Technologies purchase, which are being amortized on a straight-line
basis over three years, as well as the Company's purchase of two branches from
another financial institution in 1991 and three branches in 1998. The branch
acquisition costs are being amortized on a straight-line basis over 15 years,
respectively.
Securities sold under agreements to repurchase
The Company enters into repurchase agreements with commercial customers. The
funds are invested in an overnight sweep account and deposited back in
customers' accounts on a daily basis. These agreements are secured by pledged
securities in the Bank's investment portfolio.
Transfers of financial assets
Transfers of financial assets are accounted for as sales, when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Company does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.
- 57 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Income taxes
Deferred tax assets and liabilities are reflected at currently enacted income
tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted accordingly
through the provision for income taxes. The Bank's base amount of its federal
income tax reserve for loan losses is a permanent difference for which there is
no recognition of a deferred tax liability. However, the loan loss allowance
maintained for financial reporting purposes is a temporary difference with
allowable recognition of a related deferred tax asset, if it is deemed
realizable.
Pension plan
For the year ended December 31, 2000 compensation cost of an employee's pension
benefit is recognized on the net periodic pension cost method over the
employee's approximate service period. The aggregate cost method is utilized for
funding purposes.
The defined benefit pension plan was terminated during 2001.
Stock compensation plans
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," encourages all entities to adopt a fair value based
method of accounting for employee stock compensation plans, whereby compensation
cost is measured at the grant date based on the value of the award and is
recognized over the service period, which is usually the vesting period.
However, it also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed by
Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued
to Employees," whereby compensation cost is the excess, if any, of the quoted
market price of the stock at the grant date (or other measurement date) over the
amount an employee must pay to acquire the stock. Stock options issued under the
Company's stock option plan have no intrinsic value at the grant date, and under
Opinion No. 25 no compensation cost is recognized for them.
- 58 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Stock compensation plans (concluded)
At December 31, 2002, the Company has a stock-based compensation plan, which is
described more fully in Note 16. The Company has elected to continue with the
accounting methodology in Opinion No. 25 and, as a result, has provided pro
forma disclosures of net income and earnings per share, as if the fair value
based method of accounting had been applied. The following table illustrates the
effect on net income and earnings per share if the Company had applied the fair
value recognition provisions of SFAS No. 123 to stock-based employee
compensation.
Years Ended December 31,
------------------------
2002 2001
------- -------
(In thousands,
except per share data)
Net income, as reported $ 1,769 $ 8,911
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (324) (355)
------- -------
Pro forma net income $ 1,445 $ 8,556
======= =======
Earnings per share:
Basic-as reported $ 0.33 $ 1.42
======= =======
Basic-pro forma $ 0.27 $ 1.37
======= =======
Diluted-as reported $ 0.30 $ 1.35
======= =======
Diluted-pro forma $ 0.24 $ 1.30
======= =======
Employee stock ownership plan ("ESOP")
Compensation expense is recognized as ESOP shares are committed to be released.
Allocated and committed to be released ESOP shares are considered outstanding
for earnings per share calculations based on debt service payments. Other ESOP
shares are excluded from earnings per share calculations. Dividends declared on
allocated ESOP shares are charged to retained earnings. Dividends declared on
unallocated ESOP shares are used to satisfy debt service. The value of unearned
shares to be allocated to ESOP participants for future services not yet
performed is reflected as a reduction of stockholders' equity.
- 59 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Stock awards
The fair market value of the stock awards, based on the market price at date of
grant, is recorded as unearned compensation. Unearned compensation is amortized
over the vesting period at 20% per year. Stock award shares are considered
outstanding for basic earnings per share in the period that they vest. Stock
award shares not vested are considered in the calculation of diluted earnings
per share.
Earnings per common share
Basic earnings per share represents income available to common stockholders
divided by the weighted-average number of common shares outstanding during the
period. Diluted earnings per share reflects additional common shares that would
have been outstanding if dilutive potential common shares had been issued.
Potential common shares that may be issued by the Company related to outstanding
stock awards and stock options, and are determined using the treasury stock
method. Earnings per share data is not presented in these financial statements
for the year ended December 31, 2000 since shares of the Company common stock
were not issued until June 27, 2000.
Earnings per common share have been computed based upon the following:
Years Ended December 31,
-------------------------
2002 2001
------- -------
Net income applicable to common stock (in thousands) $ 1,769 $ 8,911
======= =======
Average number of common shares outstanding 5,686 6,264
Effect of dilutive options 181 340
------- -------
Average number of common shares outstanding
used to calculate diluted earnings per common share 5,867 6,604
======= =======
Advertising costs
Advertising costs are charged to earnings when incurred.
Trust assets
Trust assets held in a fiduciary or agent capacity are not included in the
accompanying consolidated balance sheets because they are not assets of the
Company.
- 60 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Comprehensive income
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the equity section of the
consolidated balance sheet, such items, along with net income, are components of
comprehensive income.
The components of other comprehensive income and related tax effects are as
follows for the years ended December 31, 2002, 2001 and 2000:
2002 2001 2000
-------- -------- --------
(In thousands)
Change in net unrealized holding gains/losses
on available-for-sale securities $ (5,151) $ (1,237) $ 3,768
Reclassification adjustment for gains
realized in income (15,143) (268) (423)
Reclassification adjustment for impairment
losses recognized in income 673 -- --
-------- -------- --------
Net change in unrealized gains/losses (19,621) (1,505) 3,345
Tax effects 6,327 517 (1,194)
-------- -------- --------
Net-of-tax change $(13,294) $ (988) $ 2,151
======== ======== ========
- 61 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded)
Accounting changes
The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets,"
effective January 1, 2002. Accordingly, goodwill is no longer subject to
amortization over its estimated useful life, but is subject to at least an
annual assessment for impairment by applying a fair value based test.
Additionally, under SFAS No. 142, acquired intangible assets (such as core
deposit intangibles) are separately recognized if the benefit of the intangible
asset is obtained through contractual or other legal rights, or if the
intangible asset can be sold, transferred, licensed, rented, or exchanged, and
amortized over their useful life. Branch acquisition transactions were outside
the scope of SFAS No. 142 and, accordingly, intangible assets related to such
transactions continued to amortize upon the adoption of SFAS No. 142. On October
31, 2002, the Company adopted SFAS No. 147, "Acquisitions of Certain Financial
Institutions." This Statement amends (except for transactions between two or
more mutual enterprises) previous interpretive guidance on the application of
the purchase method of accounting to acquisitions of financial institutions, and
requires the application of SFAS No. 141, "Business Combinations" and SFAS No.
142 to branch acquisitions if such transactions meet the definition of a
business combination. This Statement amends SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", to include in its scope core
deposit intangibles of financial institutions. Accordingly, such intangibles are
subject to a recoverability test based on undiscounted cash flows, and to the
impairment recognition and measurement provisions that are required for other
long-lived assets that are held and used.
SFAS No. 141 requires that the Company evaluate its intangible assets and
goodwill that were acquired in a prior purchase business combination, and to
make any necessary reclassifications in order to conform with the new criteria
for recognition apart from goodwill. No reclassifications or adjustments were
made as a result of adopting this statement. As required by SFAS No. 142 the
Company completed the annual impairment test on goodwill assets and has
concluded that the amount of recorded goodwill was not impaired as of December
31, 2002.
2. RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANK
The Bank is required to maintain cash reserve balances with the Federal Reserve
Bank based upon a percentage of certain deposits. At December 31, 2002 and 2001,
cash and due from banks included $972,000 and $11,622,000, respectively, to
satisfy such reserve requirements.
- 62 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. SHORT-TERM INVESTMENTS
Short-term investments consist of the following at December 31, 2002 and 2001:
2002 2001
------- -------
(In thousands)
Federal funds sold $17,000 $12,000
FHLB Overnight deposits 1,397 7,471
BIF Liquidity Fund 25,000 --
------- -------
$43,397 $19,471
======= =======
4. SECURITIES
The amortized cost and estimated fair value of securities, with gross unrealized
gains and losses, follows:
December 31, 2002
---------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------- -------- -------- --------
(In thousands)
Securities Available for Sale
Debt securities:
U.S. Treasury and U.S.
Government agencies $ 98,058 $ 669 $ (8) $ 98,719
Other bonds and obligations 31,284 564 (211) 31,637
Mortgage-backed securities:
FHLMC/ FNMA/GNMA 236 13 -- 249
REMIC's and CMO's 16,201 128 (118) 16,211
Asset-backed securities 6,956 43 (227) 6,772
-------- -------- -------- --------
Total debt securities 152,735 1,417 (564) 153,588
Marketable equity securities 11,132 8,526 (77) 19,581
-------- -------- -------- --------
Total securities
available for sale $163,867 $ 9,943 $ (641) $173,169
======== ======== ======== ========
Securities Held to Maturity
Debt securities:
Municipal bonds and obligations $ 7,633 $ -- $ -- $ 7,633
Mortgage-backed securities:
FHLMC/FNMA 8,648 130 (7) 8,771
REMIC's and CMO's 21,139 46 (88) 21,097
Other bonds and obligations 6,847 -- -- 6,847
-------- -------- -------- --------
Total securities
held to maturity $ 44,267 $ 176 $ (95) $ 44,348
======== ======== ======== ========
- 63 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (continued)
December 31, 2001
---------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------- -------- -------- --------
(In thousands)
Securities Available for Sale
Debt securities:
U.S. Treasury and U.S.
Government agencies $ 13,876 $ 156 $ (15) $ 14,017
Other bonds and obligations 31,017 361 (127) 31,251
Mortgage-backed securities:
FHLMC/ FNMA/GNMA 396 22 -- 418
REMIC's and CMO's 17,303 185 (27) 17,461
Asset-backed securities 1,484 12 -- 1,496
-------- -------- -------- --------
Total debt securities 64,076 736 (169) 64,643
Mutual funds 907 -- (188) 719
Marketable equity securities 10,540 28,890 (346) 39,084
-------- -------- -------- --------
Total securities
available for sale $ 75,523 $ 29,626 $ (703) $104,446
======== ======== ======== ========
Securities Held to Maturity
Debt securities:
Municipal bonds and obligations $ 11,241 $ -- $ -- $ 11,241
Mortgage-backed securities:
FHLMC/FNMA 3,358 62 (7) 3,413
REMIC's and CMO's 18,664 137 (46) 18,755
-------- -------- -------- --------
Total securities
held to maturity $ 33,263 $ 199 $ (53) $ 33,409
======== ======== ======== ========
- 64-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (concluded)
The amortized cost and estimated fair value of debt securities by contractual
maturity at December 31, 2002 is as follows. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
Available for Sale Held to Maturity
------------------------ ------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
-------- -------- -------- --------
(In thousands)
Within 1 year $ 33,168 $ 33,267 $ 6,339 $ 6,339
Over 1 year to 5 years 92,715 93,739 3,280 3,280
Over 5 years to 10 years 1,153 1,153 1,543 1,543
Over 10 years 2,306 2,197 3,318 3,318
-------- -------- -------- --------
Total bonds and obligations 129,342 130,356 14,480 14,480
Mortgage-backed and asset-backed
securities 23,393 23,232 29,787 29,868
-------- -------- -------- --------
Total debt securities $152,735 $153,588 $ 44,267 $ 44,348
======== ======== ======== ========
At December 31, 2002 and 2001, the Company has pledged securities with an
amortized cost of $6,032,000 and $5,807,000, respectively, and a fair value of
$6,185,000 and $5,882,000, respectively, as collateral for repurchase
agreements, and for its treasury tax and loan account.
For the years ended December 31, 2002, 2001 and 2000, proceeds from the sales of
securities available for sale amounted to $28,255,000, $3,965,000 and
$32,854,000, respectively. Gross realized gains amounted to $16,111,000,
$440,000 and $458,000, respectively. Gross realized losses amounted to $968,000,
$172,000 and $35,000, respectively.
- 65 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. LOANS
A summary of the balances of loans follows at December 31, 2002 and 2001:
2002 2001
--------- ---------
(In thousands)
One- to four-family mortgage $ 246,938 $ 240,852
Commercial mortgage 119,198 84,741
Multi-family mortgage 14,920 13,183
Construction and land development 17,627 22,936
Home equity lines of credit 40,713 34,439
Consumer 118,338 236,604
Commercial 165,447 170,230
--------- ---------
Total loans 723,181 802,985
Allowance for loan losses (10,308) (11,034)
Unamortized discount on purchased loans (200) (203)
Net deferred loan costs 41 172
--------- ---------
Loans, net $ 712,714 $ 791,920
========= =========
At December 31, 2002, no loans were held for sale. At December 31, 2001,
one-to-four-family mortgage loans includes $2,540,000 of loans which were held
for sale.
An analysis of the allowance for loan losses for the years ended December 31,
2002, 2001 and 2000 follows:
2002 2001 2000
-------- -------- --------
(In thousands)
Balance at beginning of year $ 11,034 $ 10,216 $ 8,534
Provision for loan losses 6,180 7,175 3,170
Loans charged-off (10,028) (7,062) (1,910)
Recoveries 3,122 705 422
-------- -------- --------
Balance at end of year $ 10,308 $ 11,034 $ 10,216
======== ======== ========
- 66 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
LOANS (concluded)
The following is a summary of information pertaining to impaired and non-accrual
loans at December 31, 2002 and 2001:
2002 2001
------ ------
(In thousands)
Impaired loans with no valuation allowance $ 727 $ 778
Impaired loans with a valuation allowance 2,123 1,359
------ ------
Total impaired loans $2,850 $2,137
====== ======
Specific valuation allowance allocated to impaired loans $ 295 $ 113
====== ======
Non-accrual loans $3,741 $2,702
====== ======
Total loans past due ninety days or more and
still accruing $ 590 $1,306
====== ======
No additional funds are committed to be advanced in connection with impaired
loans.
For the years ended December 31, 2002, 2001 and 2000, the average recorded
investment in impaired loans amounted to $2,308,000, $1,344,000 and $1,094,000,
respectively. The Company recognized $85,000, $14,000 and $16,000, respectively,
of interest income on impaired loans, during the period that they were impaired,
on the cash basis.
The Bank has sold loans in the secondary market and has retained the servicing
responsibility and receives fees for the services provided. Mortgage loans sold
and serviced for others amounted to $3,702,000 and $4,520,000 at December 31,
2002 and 2001, respectively. Consumer loans sold and serviced for others
amounted to $19,476,000 and $40,694,000 at December 31, 2002 and 2001,
respectively.
Substantially all loans serviced for others were sold without recourse
provisions and are not included in the accompanying consolidated balance sheets.
However, one commercial participation loan sale during 2002 included recourse
provisions amounting to $1,201,000 at December 31, 2002. This loan and the
recourse provision are included in the accompanying consolidated balance sheet.
- 67 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. PREMISES AND EQUIPMENT
A summary of the cost and accumulated depreciation and amortization of premises
and equipment and their estimated useful lives follows at December 31, 2002 and
2001:
Estimated
2002 2001 Useful Lives
-------- -------- ------------
(In thousands)
Banking premises:
Land $ 1,558 $ 1,558
Buildings and improvements 17,848 17,737 5 -50 years
Equipment 10,948 9,601 2 -38 years
Construction in process 203 193
-------- --------
30,557 29,089
Accumulated depreciation and
amortization (17,290) (14,876)
-------- --------
$ 13,267 $ 14,213
======== ========
Construction in process in 2002 includes a renovation project at the West
Stockbridge branch. Estimated costs to complete the project are $17,000.
Construction in process in 2001 includes a computer conversion project on the
consumer loan system. During 2002, this project was completed and costs were
transferred to the applicable categories.
Depreciation and amortization expense for the years ended December 31, 2002,
2001 and 2000 amount to $2,414,000, $2,081,000 and $1,668,000, respectively.
- 68 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. OTHER ASSETS
Other assets consist of the following at December 31, 2002 and 2001:
2002 2001
------- -------
(In thousands)
Prepaid dealer reserves $ 3,517 $ 8,594
Repossessed vehicles 838 2,549
Cash surrender values, life insurance 4,952 4,525
Other 4,008 3,533
------- -------
Total other assets $13,315 $19,201
======= =======
8. GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangibles includes goodwill associated with the acquisition
of EastPoint Technologies, LLC which is evaluated for impairment on an annual
basis. Intangible assets refer to customer relationships acquired in association
with the EastPoint Technologies purchase, which are being amortized on a
straight-line basis over three years, as well as the Company's purchase of two
branches from another financial institution in 1991 and three branches in 1998.
The branch acquisition costs are currently being amortized on a straight-line
basis over 15 years, respectively.
The changes in the carrying amounts of goodwill for the years ended December 31
are as follows:
2002 2001
------- -------
(In thousands)
Balance at beginning of year $ 4,323 $ --
Goodwill acquired during the year -- 4,551
Amortization -- 228
------- -------
Balance at end of year $ 4,323 $ 4,323
======= =======
- 69 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
GOODWILL AND OTHER INTANGIBLES (concluded)
A summary of other intangible assets at December 31 is as follows:
2002 2001
----------------------------- ----------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
------- ------------ ------- ------------
(In thousands)
Branch acquisition $ 5,311 $(2,151) $ 5,762 $(1,700)
Customer relationships 304 (304) 507 (101)
------- ------- ------- -------
$ 5,615 $(2,455) $ 6,269 $(1,801)
======= ======= ======= =======
The amortization expense on other intangible assets amounted to $654,000,
$599,000 and $549,000, respectively, for the years ended December 31, 2002, 2001
and 2000. The estimated amortization expense for each of the five succeeding
years is as follows:
Years Ending
December 31, (In thousands)
------------
2003 $ 654
2004 598
2005 497
2006 497
2007 497
A reconciliation of reported income before income taxes to adjusted income
before income taxes excluding the impacts of goodwill amortization for the years
ended December 31 are as follows:
2002 2001 2000
------- ------- -------
(In thousands)
Income before income taxes $ 2,131 $13,260 $ 6,942
Add: Goodwill amortization -- 228 --
------- ------- -------
Adjusted income before income taxes $ 2,131 $13,032 $ 6,942
======= ======= =======
-70 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. DEPOSITS
A summary of deposit balances, by type, is as follows at December 31, 2002 and
2001:
2002 2001
-------- --------
(In thousands)
Demand $ 87,149 $ 82,758
NOW 92,245 80,970
Savings 157,852 150,836
Money market 114,309 110,199
Escrow 616 729
-------- --------
Total non-certificate accounts 452,171 425,492
-------- --------
Term certificates less than $100,000 194,635 198,668
Term certificates of $100,000 or more 135,554 118,569
-------- --------
Total certificate accounts 330,189 317,237
-------- --------
Total deposits $782,360 $742,729
======== ========
A summary of certificate accounts by maturity is as follows at December 31, 2002
and 2001:
2002 2001
----------------------------- -----------------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
-------- ---- -------- ----
(Dollars in thousands)
Within 1 year $215,199 3.07% $238,270 4.49%
Over 1 year to 3 years 79,122 4.08 56,140 4.80
Over 3 years 35,868 5.43 22,827 6.08
-------- --------
$330,189 3.57% $317,237 4.67%
======== ========
- 71 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. FEDERAL HOME LOAN BANK ADVANCES
A summary of outstanding advances from the Federal Home Loan Bank of Boston, by
maturity, is as follows at December 31, 2002 and 2001:
2002 2001
------------------------- -------------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
-------- ---- -------- ----
(Dollars in thousands)
Fixed rate advances maturing:
2002 $ -- --% $ 60,000 2.84%
2002 -- -- 1,484* 6.13
2003 62,000 1.76 5,000 5.32
2003 -- -- 5,886* 4.81
2004 10,000 2.83 10,000 5.10
2004 -- -- 1,917* 6.45
2005 12,597* 3.02 -- --
2006 627 5.67 5,627 4.58
2006 -- -- 629* 6.50
2007 9,000 4.74 4,000 5.95
2007 -- -- 1,727* 6.71
2009 7,000 5.40 7,000 5.40
2010 20,000 5.84 16,000 5.74
2010 -- -- 3,084* 6.21
2011 5,610 4.95 5,610 4.95
2013 6,000 5.19 6,000 5.19
2022 168* 2.00 -- --
-------- --------
Total FHLB advances $133,002 3.27% $133,964 4.26%
======== ========
* Amortizing advances requiring monthly principal and interest payments.
At December 31, 2002, certain FHLB advances are callable in the amounts of
$42,000,000 and $5,000,000 during 2003 and 2004, respectively.
The Bank maintains a line-of-credit with the Federal Home Loan Bank of Boston
which carries interest at a rate that adjusts daily. Borrowings under the line
are limited to 2% of the Bank's total assets. All borrowings from the Federal
Home Loan Bank of Boston are secured by a blanket lien on certain qualified
collateral, defined principally as 75% of the carrying value of certain first
mortgage loans on owner-occupied residential property and 90% of the market
value of U.S. Government and federal agency securities pledged to the Federal
Home Loan Bank. No amounts were outstanding under this line during 2002 and
2001.
- 72 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase ("repurchase agreements") are
funds borrowed from customers on an overnight basis that are secured by
investment securities.
A summary of repurchase agreements is as follows for the years ended December
31, 2002 and 2001:
2002 2001
------ ------
(Dollars in thousands)
Balance at year end $ 700 $1,890
Fair value of securities underlying the
agreements at year end $2,542 $2,312
Interest rate on year end balance 1.59% 1.74%
Average amount outstanding during year $1,349 $1,584
Maximum amount outstanding at
any month-end $1,830 $2,340
Weighted average interest rate during the year 1.72% 3.78%
The Bank also has a repurchase agreement line of credit with the Depositors
Insurance Fund of up to $2,000,000 to be secured by securities or other assets
of the Bank. As of December 31, 2002 and 2001, there were no outstanding
borrowings against this agreement.
12. INCOME TAXES
Allocation of federal and state income taxes between current and deferred
portions is as follows for the years ended December 31, 2002, 2001 and 2000:
2002 2001 2000
------- -------- --------
(In thousands)
Current tax provision:
Federal $ 644 $ 3,496 $ 4,024
State 149 245 1,121
------- -------- --------
793 3,741 5,145
------- -------- --------
Deferred tax provision (benefit):
Federal (340) 531 (1,822)
State (91) 77 (561)
------- -------- --------
(431) 608 (2,383)
------- -------- --------
Change in valuation reserve -- -- (402)
------- -------- --------
$ 362 $ 4,349 $ 2,360
======= ======== ========
- 73 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (concluded)
The reasons for the differences between the statutory federal income tax rate
and the effective tax rates is summarized as follows for the years ended
December 31, 2002, 2001 and 2000:
2002 2001 2000
------- -------- --------
Statutory tax rate 34.0% 34.0% 34.0%
Increase (decrease) resulting from:
State taxes, net of federal tax benefit 1.8 1.6 5.3
Dividends received deduction (10.0) (1.9) (3.3)
Tax exempt income (7.5) (1.0) (0.8)
Change in valuation reserve -- -- (5.8)
Other, net (1.3) 0.1 4.6
------- -------- --------
Effective tax rates 17.0% 32.8% 34.0%
======= ======== ========
The components of the net deferred tax (asset) liability are as follows at
December 31, 2002 and 2001:
2002 2001
-------- --------
(In thousands)
Deferred tax liability:
Federal $ 3,418 $ 10,352
State 1,098 623
-------- --------
4,516 10,975
-------- --------
Deferred tax asset:
Federal (5,332) (5,090)
State (1,369) (1,312)
-------- --------
(6,701) (6,402)
-------- --------
Net deferred tax (asset) liability $ (2,185) $ 4,573
======== ========
- 74 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (continued)
The tax effects of each type of income and expense item that give rise to
deferred taxes are as follows at December 31, 2002 and 2001:
2002 2001
-------- --------
(In thousands)
Investments:
Net unrealized gain on securities
available for sale $ 3,760 $ 10,087
Other 164 653
Depreciation (9) 16
Allowance for loan losses (3,999) (4,295)
Employee benefit plans (732) (736)
Charitable contribution carryover (1,219) (1,288)
Other (150) 136
-------- --------
Net deferred tax (asset) liability $ (2,185) $ 4,573
======== ========
A summary of the change in the net deferred tax (asset) liability is as follows
for the years ended December 31, 2002, 2001 and 2000:
2002 2001 2000
------- ------- -------
(In thousands)
Balance at beginning of year $ 4,573 $ 4,482 $ 6,073
Deferred tax (benefit) provision (431) 608 (2,383)
Change in deferred tax effects of net unrealized
gains/losses on securities available for sale (6,327) (517) 1,194
Utilization of valuation reserve -- -- (402)
------- ------- -------
Balance at end of year $(2,185) $ 4,573 $ 4,482
======= ======= =======
- 75 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (concluded)
A summary of the change in the valuation reserve applicable to the deferred tax
assets is as follows for the year ended December 31, 2000:
2000
-----
(In thousands)
Balance at beginning of year $ 402
Benefits utilized by current year operations (402)
Change in future income assumptions --
-----
Balance at end of year $ --
=====
The valuation reserve at December 31, 1999 related primarily to a charitable
contribution carryover, which was used in full by December 31, 2000. There is a
new contribution carryover at December 31, 2000, which expires in 2005.
Management believes that the deferred tax assets related to this contribution
carryover and other deductible temporary differences will be realized. As a
result, no valuation reserve has been established at December 31, 2002, December
31, 2001 or December 31, 2000.
The federal income tax reserve for loan losses at the Bank's base year is
$844,000. If any portion of the reserve is used for purposes other than to
absorb the losses for which established, approximately 150% of the amount
actually used (limited to the amount of the reserve) would be subject to
taxation in the fiscal year in which used. As the Bank intends to use the
reserve only to absorb loan losses, a deferred income tax liability of $346,000
has not been provided.
13. OFF-BALANCE SHEET ACTIVITIES
In the normal course of business, there are outstanding commitments and
contingencies which are not reflected in the accompanying consolidated financial
statements.
Credit related financial instruments
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Such commitments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
accompanying consolidated balance sheets.
- 76 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
OFF-BALANCE SHEET ACTIVITIES (continued)
Credit related financial instruments (concluded)
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument is represented by the contractual amount
of these commitments. The Company uses the same credit policies in making
commitments as it does for on-balance-sheet instruments. A summary of financial
instruments outstanding whose contract amounts represent credit risk is as
follows at December 31, 2002 and 2001:
2002 2001
------- -------
(In thousands)
Commitments to grant loans $30,815 $23,031
Unused funds on commercial lines-of-credit 47,900 46,059
Unadvanced funds on home equity and reddi-cash
lines of credit 42,671 38,909
Unadvanced funds on construction loans 19,161 8,659
Standby letters of credit 1,894 1,817
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. The commitments for lines of credit may expire without
being drawn upon. Therefore, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's credit
worthiness on a case-by-case basis. Funds to be disbursed for loans and home
equity lines of credit are collateralized by real estate. Commercial lines of
credit are generally secured by business assets and securities. Reddi-cash lines
of credit are unsecured.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. These letters of
credit are primarily issued to support borrowing arrangements. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers.
-77 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
OFF-BALANCE SHEET ACTIVITIES (continued)
Operating lease commitments
Pursuant to the terms of noncancelable lease agreements in effect at December
31, 2002, pertaining to banking premises and equipment, future minimum rent
commitments are as follows:
Years Ending
December 31, (In thousands)
------------
2003 $ 450
2004 450
2005 404
2006 351
2007 351
Thereafter 1,789
--------
$ 3,795
========
The leases contain options to extend for periods up to twenty years. The cost of
such rental options is not included above. Total rent expense for the years
ended December 31, 2002, 2001 and 2000 amounted to $391,000, $375,000 and
$593,000, respectively.
Employment and change in control agreements
The Company and the Bank have entered into employment agreements with certain
senior executives that generally provide for a specified minimum annual
compensation, participation in stock benefit plans and the continuation of
benefits currently received. The original terms of the agreements are for three
years and automatically extend unless either party gives notice to the contrary.
However, such agreements may be terminated for cause, as defined, without
incurring any continuing obligations.
The Bank has also entered into change in control agreements with certain
officers, all of whom are not covered by an employment agreement. The change in
control agreements generally provide a severance payment if the officer is
terminated following a "change in control," as defined in the agreements.
- 78 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
OFF-BALANCE SHEET ACTIVITIES (concluded)
Legal claims
Various legal claims also arise from time to time in the normal course of
business which, in the opinion of management, will have no material effect on
the Company's consolidated financial statements.
Contingency
In November 2002, the Bank received a "Notice of Intent to Assess" from the
Commonwealth of Massachusetts Department of Revenue ("DOR") and, subsequently,
in January 2003, received a "Notice of Assessment." The notices indicate that
the Bank owes approximately $780,000 in additional state taxes and interest, for
the tax year ended December 31, 2001, related to the denial by the DOR of the
Bank's claim of a dividends received deduction for dividends received from the
Bank's real estate investment trust ("REIT") subsidiary. There is no possible
assessment relating to the December 31, 2002 return due to the loss incurred by
the Bank on a separate company basis.
The DOR contends that dividend distributions by the Bank's subsidiary, Gold Leaf
Capital Corp. (the "Subsidiary") to the Bank are fully taxable in Massachusetts.
The Bank believes that the Massachusetts statute that provides for a dividends
received deduction equal to 95% of certain dividend distributions applies to the
distributions made by the Subsidiary to the Bank. Accordingly, no provision has
been made in the Bank's consolidated financial statements for the amounts
assessed or additional amounts that might be assessed in the future. The Bank
has appealed the assessment and will pursue all available means to defend its
position. Assessed amounts ultimately paid, if any, would be deductible expenses
for federal income tax purposes (see Note 23). The additional liability, net of
the federal benefit, would be $513,000.
- 79 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14. STOCKHOLDERS' EQUITY
Minimum regulatory capital requirements
The Company (on a consolidated basis) and the Bank are subject to various
regulatory capital requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory and
possibly additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on the Company's and the Bank's consolidated
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company and the Bank must meet
specific capital guidelines that involve quantitative measures of their assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors. Prompt corrective action provisions are not applicable to savings
and loan holding companies.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
following table) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2002 and 2001, that
the Bank met the capital adequacy requirements.
As of December 31, 2002, Berkshire Bank met the conditions to be classified as
well capitalized under the regulatory framework for prompt corrective action. To
be categorized as well capitalized, an institution must maintain minimum total
risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the
following tables. Management has determined to maintain capital levels in an
amount in excess of the regulatory requirements and in consideration of the
amount of lower quality of sub-prime automobile loans in the loan portfolio.
- 80 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCKHOLDERS' EQUITY (continued)
The Company's and Bank's actual capital amounts and ratios as of December 31,
2002 and 2001 are also presented in the table.
December 31, 2002
-------------------------------------------------------------------------------------
Minimum
To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Requirement Action Provisions
----------------------- ----------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
Total capital to risk weighted assets:
Berkshire Hills Bancorp, Inc. $118,293 15.21% $ 62,233 8.0% N/A N/A
Berkshire Bank 104,256 13.55 61,544 8.0 $ 76,929 10.0%
Tier 1 capital to risk weighted assets:
Berkshire Hills Bancorp, Inc. 104,760 13.47 31,116 4.0 N/A N/A
Berkshire Bank 90,829 11.81 30,772 4.0 46,158 6.0
Tier 1 capital to average assets:
Berkshire Hills Bancorp, Inc. 104,760 10.05 41,706 4.0 N/A N/A
Berkshire Bank 90,829 8.78 41,394 4.0 51,743 5.0
- 81 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCKHOLDERS' EQUITY (concluded)
Minimum regulatory capital requirements (concluded)
December 31, 2001
-------------------------------------------------------------------------------------
Minimum
To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Requirement Action Provisions
----------------------- ----------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
Total capital to risk weighted assets:
Berkshire Hills Bancorp, Inc. $133,240 15.73% $ 67,749 8.0% N/A N/A
Berkshire Bank 111,640 13.38 66,749 8.0 $ 83,437 10.0%
Tier 1 capital to risk weighted assets:
Berkshire Hills Bancorp, Inc. 109,895 12.98 33,874 4.0 N/A N/A
Berkshire Bank 88,450 10.60 33,375 4.0 50,062 6.0
Tier 1 capital to average assets:
Berkshire Hills Bancorp, Inc. 109,895 11.02 39,896 4.0 N/A N/A
Berkshire Bank 88,450 9.05 39,108 4.0 48,885 5.0
Common stock
On March 28, 2001, the Board of Directors approved a dividend reinvestment plan
and authorized its implementation. The plan, which is available to all
shareholders of record of the Company's common stock, permits the reinvestment
of all cash dividends, the deposit of shares for safekeeping and the sale and
gifting of shares held under the plan. Common shares purchased pursuant to this
plan were 7,504 shares. All shares are purchased in open market transactions.
During 2001, the Company repurchased approximately 1,249,000 shares of
outstanding common stock. The Company announced in April of 2002 that its Board
of Directors approved a fifth repurchase program for 312,516 shares or 5%, of
its outstanding common stock and at December 31, 2002, the Company had 172,416
shares remaining to be purchased in the latest 5% repurchase. During 2002 a
total of approximately 315,000 shares were repurchased.
- 82 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
15. EMPLOYEE BENEFIT PLANS
Defined benefit pension plan
The Company terminated its defined benefit pension plan effective February 24,
2001. During the second quarter of 2001, the Company recorded a loss of $168,000
from the curtailment of its defined benefit pension plan. The final plan
settlement was approved by the IRS in the fourth quarter. The settlement gain
was $2,341,000.
Defined contribution pension plan
The Company has a qualified savings plan under Section 401(k) of the Internal
Revenue Code. Each employee reaching the age of 21 and having completed at least
1,000 hours of service in a twelve-month period, beginning with such employee's
date of employment, automatically becomes a participant in the 401(k) Plan.
Employees may contribute a portion of their compensation subject to certain
limits based on federal tax laws. The Company made matching contributions which
amounted to $640,000, $528,000 and $237,000, respectively, for the years ended
December 31, 2002, 2001 and 2000.
Supplemental executive retirement plan
The Company has a nonqualified supplemental executive retirement plan for the
benefit of a certain senior executive. Benefits generally commence no earlier
than age sixty and continue for the life of the senior executive. As of December
31, 2002 and 2001, the Company has an accrued expense payable in the amount of
$760,000, representing the present value of future payments under the
supplemental retirement plan. In some instances, the Company has also entered
into split-dollar life insurance agreements with senior executives to provide
supplemental retirement benefits.
Incentive plan
The Company has an incentive plan ("the Plan") whereby all management and staff
members are eligible to receive a bonus, tied to performance. The structure of
the Plan is to be reviewed on an annual basis by the Executive Committee. The
Plan year end is December 31. Incentive compensation expense for the years ended
December 31, 2002, 2001 and 2000 amounted to $620,000, $600,000 and $874,000,
respectively.
Other benefits
The Company has in the past offered its retirees optional medical insurance
coverage. All participating retirees are required to contribute in part to the
cost of this coverage. The retiree medical plan was terminated on December 31,
1996. Any retiree participating in the plan at that time will continue to be
covered for life, however, no new retirees can participate in this plan. At
December 31, 2002 and 2001, the Company had an accrued liability in the amount
of $487,000 and $535,000, respectively, for payment of future premiums under
this plan.
- 83 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
16. STOCK-BASED INCENTIVE PLAN AND EMPLOYEE STOCK OWNERSHIP PLAN
Stock-based incentive plan
Stock options
Under the Company's Stock-Based Incentive Plan, the Company may grant options to
its directors, officers and employees for up to 767,366 shares of common stock.
Both incentive stock options and non-statutory stock options may be granted
under the plan. The exercise price of each option equals the market price of the
Company's stock on the date of grant and an option's maximum term is ten years.
Options vest at 20% per year.
A summary of the status of the Company's stock options for the years ended
December 31, 2002 and 2001 are presented below:
2002 2001
-------------------------- -------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
--------- --------- --------- ---------
Fixed Options:
Outstanding at beginning of year 767,366 $ 16.75 -- $ --
Granted -- -- 767,366 16.75
Exercised (6,907) 16.75 -- --
Forfeited (159,611) 16.75 -- --
--------- ---------
Outstanding at end of year 600,848 $ 16.75 767,366 $ 16.75
========= =========
Options exercisable at year-end 146,573 $ 16.75 -- $ --
Weighted-average fair value of
options granted during the year $ -- $ 3.44
- 84 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK-BASED INCENTIVE PLAN AND EMPLOYEE STOCK OWNERSHIP PLAN (continued)
Stock-based incentive plan (continued)
Stock options (concluded)
The fair value of each option grant is estimated on the date of grant using the
Modified Roll Geske option-pricing model with the following weighted-average
assumptions:
Year Ended
December 31,
2001
------------
Dividend yield 2.12%
Expected life in years 10 years
Expected volatility 18.01%
Risk-free interest rate 5.12%
No options were granted during the year ended December 31, 2002.
Information pertaining to options outstanding at December 31, 2002 and 2001 are
as follows:
Years Ended December 31,
------------------------------------
2002 2001
--------- ---------
Number outstanding 600,848 767,366
Exercise price $ 16.75 $ 16.75
Weighted average remaining
contractual life 8.2 years 9.2 years
Number exercisable 146,573 --
Stock awards
Under the Company's Stock-Based Incentive Plan, the Company may grant stock
awards to its directors, officers and employees for up to 306,950 shares of
common stock. The Company applies APB Opinion No. 25 and related Interpretations
in accounting for stock awards. The stock awards vest at 20% per year. The fair
market value of the stock allocations, based on the market price at date of
grant, is recorded as unearned compensation. Unearned compensation is amortized
over the periods to be benefited. The Company recorded compensation cost related
to the stock awards of approximately $1,165,000 and $1,000,000 in 2002 and 2001,
respectively. No compensation expense was recorded in 2000 as the plan was
approved in 2001.
- 85 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK-BASED INCENTIVE PLAN AND EMPLOYEE STOCK OWNERSHIP PLAN (continued)
Stock-based incentive plan (concluded)
Stock awards (concluded)
A summary of the status of the Company's stock awards is presented below:
Years Ended December 31,
-----------------------------
2002 2001
--------- ---------
Balance at beginning of year 306,945 --
Granted -- 306,945
Cancelled (100,676) --
--------- ---------
Balance at end of year 206,269 306,945
========= =========
Fair value of stock awards granted during the year $ -- $ 17.76
========= =========
Employee Stock Ownership Plan
The Company has established an Employee Stock Ownership Plan (the "ESOP") for
the benefit of each employee that has reached the age of 21 and has completed at
least 1,000 hours of service in the previous twelve-month period. As part of the
conversion, Berkshire Hills Funding Corporation provided a loan to the Berkshire
Bank Employee Stock Ownership Plan Trust which was used to purchase 8%, or
613,900 shares, of the Company's outstanding stock in the open market. The loan
bears interest equal to 9.5% and provides for quarterly payments of interest and
principal.
At December 31, 2002, the remaining principal balance is payable as follows:
Years Ending
December 31, (In thousands)
- ------------
2003 $ 269
2004 294
2005 325
2006 356
2007 392
Thereafter 4,886
--------
$ 6,522
========
- 86 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK-BASED INCENTIVE PLAN AND EMPLOYEE STOCK OWNERSHIP PLAN (concluded)
Employee Stock Ownership Plan (concluded)
The Bank has committed to make contributions to the ESOP sufficient to support
the debt service of the loan. The loan is secured by the shares purchased which
are held in a suspense account for allocation among the participants as the loan
is paid. Total compensation expense applicable to the ESOP amounted to $887,000
and $773,000 for the years ended December 31, 2002 and 2001, respectively.
Shares held by the ESOP include the following at December 31, 2002 and 2001:
2002 2001
--------- ---------
Allocated 83,954 43,016
Committed to be allocated 37,853 40,938
Unallocated 492,093 529,946
--------- ---------
613,900 613,900
========= =========
Cash dividends received on allocated shares are allocated to participants and
cash dividends received on shares held in suspense are applied to repay the
outstanding debt of the ESOP. The fair value of these shares was approximately
$11,589,000 and $12,431,000 at December 31, 2002 and 2001, respectively.
17. RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Company has granted loans to directors
and officers and their affiliates. All loans and commitments included in such
transactions were made on substantially the same terms, including interest rates
and collateral, as those prevailing at the time for comparable transactions with
other persons. All loans to directors and officers of the Company and their
affiliates are performing in accordance with the contractual terms of the loans
as of December 31, 2002.
- 87 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
RELATED PARTY TRANSACTIONS (concluded)
An analysis of activity of such loans which aggregate more than $60,000 on an
individual basis to directors and executive officers of the Company and their
affiliates is as follows:
Years Ended December 31,
---------------------------
2002 2001
--------- ---------
(In thousands)
Balance at beginning of year $ 6,089 $ 3,967
Additions 658 2,941
Repayments (1,007) (819)
--------- ---------
Balance at end of year $ 5,740 $ 6,089
========= =========
18. RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES
Federal and state banking regulations place certain restrictions on dividends
paid and loans or advances made by the Bank to the Company. The total amount of
dividends which may be paid at any date is generally limited to the retained
earnings of the Bank, and loans or advances are limited to 10% of the Bank's
capital stock and surplus on a secured basis.
At December 31, 2002 and 2001, the Bank's retained earnings available for the
payment of dividends was $61,544,000 and $66,749,000, respectively, and funds
available for loans or advances amounted to $10,426,000 and $11,164,000,
respectively.
In addition, dividends paid by the Bank to the Company would be prohibited if
the effect thereof would cause the Bank's capital to be reduced below applicable
minimum regulatory capital requirements.
In conjunction with Massachusetts conversion regulations, the Bank established a
liquidation account for eligible account holders which at the time of conversion
amounted to approximately $70 million. In the event of a liquidation of the
Bank, the eligible account holders will be entitled to receive their pro-rata
share of the net worth of the Bank prior to conversion. However, as qualifying
deposits are reduced, the liquidation account will also be reduced in an amount
proportionate to the reduction in the qualifying deposit accounts.
- 88-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
19. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the current amount that would be
exchanged between willing parties, other than in a forced liquidation. Fair
value is best determined based upon quoted market prices. However, in many
instances, there are no quoted market prices for the Company's various financial
instruments. In cases where quoted market prices are not available, fair values
are based on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. Accordingly, the fair value
estimates may not be realized in an immediate settlement of the instrument. SFAS
107 excludes certain financial instruments and all nonfinancial instruments from
its disclosure requirements. Accordingly, the aggregate fair value amounts
presented may not necessarily represent the underlying fair value of the
Company.
The following methods and assumptions were used by the Company in estimating
fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts of these instruments approximate
fair values.
Securities: Fair values for securities, excluding FHLB and SBLI stock, are based
on quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments. The carrying value of FHLB stock approximates fair value based on
the redemption provisions of the Federal Home Loan Bank and SBLI stock was
recorded at fair value at acquisition as determined by an appraisal performed by
independent investment consultants retained by SBLI.
Loans: For variable-rate loans that reprice frequently and with no significant
change in credit risk, fair values are based on carrying values. Fair values for
all other loans are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality.
Deposits: The fair values for non-certificate accounts and tax escrow are, by
definition, equal to the amount payable on demand at the reporting date which is
their carrying amounts. Fair values for certificates of deposit are estimated
using a discounted cash flow calculation that applies interest rates currently
being offered on certificates to a schedule of aggregated expected monthly
maturities on time deposits.
Federal Home Loan Bank advances: The fair values of Federal Home Loan Bank
advances are estimated using discounted cash flow analyses based on the Bank's
current incremental borrowing rates for similar types of borrowing arrangements.
- 89 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS (concluded)
Securities sold under agreements to repurchase: The carrying amount of
repurchase agreements approximates fair value. Repurchase agreements generally
mature or "roll over" on a daily basis.
Accrued interest: The carrying amounts of accrued interest approximate fair
value.
Off-balance-sheet instruments: Fair values for off-balance-sheet lending
commitments are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
counterparties' credit standing. The fair values of off-balance sheet
instruments are immaterial.
The carrying amounts and estimated fair values of the Company's financial
instruments are as follows at December 31, 2002 and 2001:
2002 2001
-------------------------- --------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- -------- -------- --------
(In thousands)
Financial assets:
Cash and cash equivalents $ 60,655 $ 60,655 $ 42,123 $ 42,123
Securities available for sale 173,169 173,169 104,446 104,446
Securities held to maturity 44,267 44,348 33,263 33,409
Federal Home Loan Bank stock 7,440 7,440 7,027 7,027
Loans, net 712,714 725,000 791,920 800,669
Accrued interest receivable 5,125 5,125 5,873 5,873
Savings Bank Life Insurance stock 2,043 2,043 2,043 2,043
Financial liabilities:
Deposits 782,360 759,325 742,729 748,615
Federal Home Loan Bank advances 133,002 146,258 133,964 137,748
Securities sold under agreements
to repurchase 700 700 1,890 1,890
- 90 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
20. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Condensed financial information pertaining only to the parent company, Berkshire
Hills Bancorp, Inc. which commenced operations on June 27, 2000 is as follows:
CONDENSED BALANCE SHEETS
December 31,
--------------------------
2002 2001
-------- --------
(In thousands)
Assets
Cash due from Berkshire Bank $ 3,075 $ 6,777
Securities available for sale, at fair value 31 587
Securitiies held to maturity 3,463 5,532
Investment in common stock of Berkshire Bank 101,667 113,050
Investment in common stock of Berkshire Hills
Funding Corporation 6,690 6,949
Investment in common stock of Berkshire
Hills Technology, Inc. 3,703 4,743
Other assets 1,629 1,712
-------- --------
Total assets $120,258 $139,350
======== ========
Liabilities and Stockholders' Equity
Accounts payable $ 18 $ 27
Stockholders' equity 120,240 139,323
-------- --------
Total liabilities and stockholders' equity $120,258 $139,350
======== ========
- 91 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (continued)
CONDENSED STATEMENTS OF INCOME
Years Ended December 31,
--------------------------------
2002 2001 2000
-------- -------- --------
(In thousands)
Income:
Dividends from Berkshire Bank $ 2,375 $ 14,650 $ 800
Dividends from Berkshire Hills Funding Corporation 577 1,700 --
Interest on securities 273 779 205
Other 44 206 --
-------- -------- --------
Total income 3,269 17,335 1,005
-------- -------- --------
Operating expenses:
Charitable contribution -- -- 5,684
Other 405 459 72
-------- -------- --------
Total operating expenses 405 459 5,756
-------- -------- --------
Income (loss) before income taxes and equity in
undistributed income (loss) of subsidiaries 2,864 16,876 (4,751)
Applicable income tax provision (benefit) 80 138 (1,932)
-------- -------- --------
Income (loss) before equity in undistributed
income (loss) of subsidiaries 2,784 16,738 (2,819)
Equity in undistributed income (loss) of Berkshire Bank 284 (6,799) 7,082
Equity in undistributed income (loss) of Berkshire Hills
Funding Corporation (259) (1,071) 319
Equity in undistributed (loss) income of Berkshire Hills
Technology, Inc. (1,040) 43 --
-------- -------- --------
Net income $ 1,769 $ 8,911 $ 4,582
======== ======== ========
- 92 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (concluded)
CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31,
--------------------------------
2002 2001 2000
-------- -------- --------
(In thousands)
Cash flows from operating activities:
Net income $ 1,769 $ 8,911 $ 4,582
Adjustments to reconcile net income
to net cash provided by operating activities:
Equity in undistributed (income) loss of Berkshire Bank (284) 6,799 (7,082)
Equity in undistributed loss (income) of Berkshire Hills
Funding Corporation 259 1,071 (319)
Equity in undistributed income of
Berkshire Hills Technology, Inc. 1,040 (43) --
Charitable contribution in the form of Berkshire Hills
Bancorp, Inc. common stock -- -- 5,684
Deferred tax benefit -- (310) (1,598)
Net accretion (amortization) of securities (4) 5 (10)
Other, net 499 591 (320)
-------- -------- --------
Net cash provided by operating activities 3,279 17,024 937
-------- -------- --------
Cash flows from investing activities:
Activity in available-for-sale securities:
Sales -- 5,666 1,000
Maturities -- 2,920 --
Principal payments 560 -- --
Purchases -- (4,623) (5,600)
Activity in held-to-maturity securities:
Maturities 1,932 12,553 1,950
Principal payments 169 135 25
Purchases (32) (8,838) (11,358)
Investment in Berkshire Bank -- -- (34,192)
Investment in Berkshire Hills Funding Corporation -- -- (7,701)
Investment in Berkshire Hills Technology, Inc. -- (4,700) --
-------- -------- --------
Net cash provided by (used in) investing activities 2,629 3,113 (55,876)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock -- -- 68,386
Proceeds from issuance of treasury stock 116 -- --
Payments to acquire treasury stock (6,989) (23,292) --
Dividends paid (2,737) (2,808) (707)
-------- -------- --------
Net cash (used in) provided by investing activities (9,610) (26,100) 67,679
-------- -------- --------
Net change in cash and cash equivalents (3,702) (5,963) 12,740
Cash and cash equivalents at beginning of period 6,777 12,740 --
-------- -------- --------
Cash and cash equivalents at end of period $ 3,075 $ 6,777 $ 12,740
======== ======== ========
- 93-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
21. SEGMENT REPORTING
The Company has one reportable segment, the Bank, and two operating segments,
the Bank and Berkshire Hills Technology, Inc. Each segment is described in Note
1 under business.
Information about reportable segments, and reconciliation of such information to
the consolidated financial statements as of and for the years ended December 31,
follows:
Berkshire Hills Consolidated
2002 Bank Technology, Inc. Totals
- ---- ----------- --------------- ------------
(In thousands)
Net interest income $ 64,128 $ -- $ 64,128
Depreciation and amortization 1,813 601 2,414
Provision for loan losses 6,180 -- 6,180
Licensing fees -- 6,991 6,991
Minority interest -- (685) (685)
Profit/loss 2,809 (1,040) 1,769
Assets 1,037,047 8,571 1,045,618
Expenditures for additions
to premises and equipment 1,042 426 1,468
2001
- ----
Net interest income $ 75,796 $ -- $ 75,796
Depreciation and amortization 1,769 312 2,081
Provision for loan losses 7,175 -- 7,175
Licensing fees -- 3,465 3,465
Minority interest -- (119) (119)
Profit 8,868 43 8,911
Assets 1,021,623 9,078 1,030,701
Expenditures for additions
to premises and equipment 735 1,609 2,344
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates performance
based on profit or loss from operations before income taxes not including
nonrecurring gains or losses.
The Company's operating segments are strategic business units that offer
different products and services. They are managed separately because each
segment appeals to different markets and, accordingly, requires different
technology and marketing strategies.
- 94 -
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEGMENT REPORTING (concluded)
The Company derives a majority of its revenues from interest income and
licensing fees and the chief operating decision maker relies primarily on net
interest revenue and licensing fees to assess the performance of the segments
and make decisions about resources to be allocated to the segment. Therefore,
the segments are reported using net interest income and licensing fees for the
years ended December 31. The Company does not allocate income taxes to the
segments.
The Company does not have a single external customer from which it derives 10
percent or more of its revenues and operates in one geographical area.
22. QUARTERLY DATA (UNAUDITED)
Quarterly results of operations for the years ended December 31, 2002 and 2001
are as follows:
2002 2001
--------------------------------------------- --------------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
-------- -------- -------- -------- -------- -------- -------- --------
(In thousands, except per share data)
Interest and dividend income $ 14,549 $ 19,096 $ 19,264 $ 16,560 $ 18,300 $ 19,096 $ 19,264 $ 19,136
Interest expense 5,547 8,463 8,751 6,086 7,233 8,463 8,751 9,113
-------- -------- -------- -------- -------- -------- -------- --------
Net interest income 9,002 10,633 10,513 10,474 11,067 10,633 10,513 10,023
Provision for loan losses (1) 2,305 945 840 1,510 4,550 945 840 840
Other income 4,328 3,606 1,447 2,744 4,420 3,606 1,447 1,110
Operating expenses (2) 17,869 9,429 7,374 9,226 8,380 9,429 7,374 7,201
Provision (benefit) for
income taxes (255) 1,258 1,239 806 838 1,258 1,239 1,014
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) $ (6,589) $ 2,607 $ 2,507 $ 1,676 $ 1,719 $ 2,607 $ 2,507 $ 2,078
======== ======== ======== ======== ======== ======== ======== ========
Earnings per share:
Basic $ (0.80) $ 0.42 $ 0.39 $ 0.30 $ 0.30 $ 0.42 $ 0.39 $ 0.31
Diluted (0.80) 0.40 0.37 0.28 0.28 0.40 0.37 0.30
Note: (1) The increase in the fourth quarter 2001 provision for loan
losses is attributable to a more aggressive charge-off policy
for automobile loans.
(2) The increase in the fourth quarter operating expenses is
primarily due to severance expenses, funding of the retirement
plan benefit for directors and the write down in value of
repossessed automobiles.
-95-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Concluded)
23. SUBSEQUENT EVENTS
In January 2003, legislation was proposed in Massachusetts which retroactively
prohibits use of the 95% dividends received deduction when the dividends are
received from a REIT, effective for tax years beginning in 1999. On March 5,
2003, the Governor of Massachusetts signed the legislation. As a result, the
Company has ceased recording tax benefits associated with the dividends received
deduction effective for the 2003 tax year and accrued $513,000, representing the
amount of tax benefits realized by the Company through the dividends received
deduction through the 2002 tax year. Such amount includes interest assessed by
the Massachusetts Department of Revenue through December 31, 2002. The Company
intends to vigorously appeal the retroactive nature of the provision.
-96 -
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information concerning the directors of the Company, the information
contained under the sections captioned "Proposal I -- Election of Directors" in
Berkshire Hills' Proxy Statement for the 2003 Annual Meeting of Stockholders is
incorporated by reference. For information concerning officers of the Company,
reference is made to Part I, Item 1 A, "Business--Executive Officers of the
Registrant" in this report. Reference is made to the cover page of this report
and to the section captioned "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Proxy Statement for information regarding compliance with
Section 16(a) of the Exchange Act.
ITEM 11. EXECUTIVE COMPENSATION
The information contained under the sections captioned "Executive
Compensation" and "Directors Compensation" in the Proxy Statement is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by
reference to the section captioned "Stock Ownership" in the Proxy
Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by
reference to the section captioned "Stock Ownership" in the Proxy
Statement.
(c) Management of Berkshire Hills knows of no arrangements, including
any pledge by any person of securities of Berkshire Hills, the
operation of which may at a subsequent date result in a change in
control of the registrant.
(d) Equity Compensation Plan Information:
Information required by this item is incorporated herein by
reference to the section captioned "Proposal 2- Approval of 2003
Equity Compensation Plan" in the Proxy statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference
to the section captioned "Transactions with Management" in the Proxy Statement.
- 97 -
PART IV
ITEM 14. CONTROLS and PROCEDURES
(a) Evaluation of disclosure controls and procedures. The Company
maintains controls and procedures designed to ensure that
information required to be disclosed in the reports that the Company
files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods
specified in the rules and forms of the Securities and Exchange
Commission. Based upon their evaluation of those controls and
procedures performed within 90 days of the filing date of this
report, the chief executive officer and the chief financial officer
of the Company concluded that the Company's disclosure controls and
procedures were adequate.
(b) Changes in internal controls. The Company made no significant
changes in its internal controls or in other factors that could
significantly affect these controls subsequent to the date of the
evaluation of those controls by the chief executive officer.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) [1] Financial Statements
o Independent Auditors' Report
o Consolidated Balance Sheets as of December 31, 2002 and 2001
o Consolidated Statements of Income for the Years Ended December
31, 2002, 2001 and 2000
o Consolidated Statements of Changes in Stockholders' Equity for
the Years Ended December 31, 2002, 2001, and 2000
o Consolidated Statements of Cash Flows for the Years Ended
December 31, 2002, 2001, and 2000
o Notes to Consolidated Financial Statements
[2] Financial Statement Schedules
All financial statement schedules are omitted because they are not
required or applicable. The required information is shown in the
consolidated financial statements or the notes thereto.
[3] Exhibits
3.1 Certificate of Incorporation of Berkshire Hills Bancorp,
Inc.(1)
3.2 Bylaws of Berkshire Hills Bancorp, Inc.(2)
4.0 Draft Stock Certificate of Berkshire Hills Bancorp, Inc.(1)
10.1 Employment Agreement between Berkshire Bank and Robert A.
Wells(3)
10.2 Employment Agreement between Berkshire Hills Bancorp, Inc. and
Robert A. Wells(3)
10.3 Employment Agreement between Berkshire Bank and Michael P.
Daly(3)
10.4 Employment Agreement between Berkshire Hills Bancorp, Inc. and
Michael P. Daly(3)
10.5 Severance Agreement, dated October 16, 2002, by and among
James A. Cunningham, Jr., Berkshire Hills Bancorp, Inc. and
Berkshire Bank(4)
10.6 Severance Agreement, dated November 13, 2002, by and among
Charles F. Plungis, Jr., Berkshire Hills Bancorp, Inc. and
Berkshire Bank(2)
- 98 -
10.7 Severance Agreement, dated November 13, 2002, by and among
Susan M. Santora, Berkshire Hills Bancorp, Inc. and Berkshire
Bank(2)
10.8 Change in Control Agreement between Berkshire Bank and Gayle
P. Fawcett
10.9 Change in Control Agreement between Berkshire Hills Bancorp,
Inc. and Gayle P. Fawcett
10.10 Form of Berkshire Bank Employee Severance Compensation Plan(1)
10.11 Form of Berkshire Bank Supplemental Executive Retirement
Plan(1)
10.12 Berkshire Hills Bancorp, Inc. 2001 Stock-Based Incentive
Plan(5)
11.0 Statement re: Computation of Per Share Earnings
21.0 Subsidiary Information is incorporated herein by reference to
Part I, Item 1, "Business - Subsidiary Activities"
23.0 Consent of Wolf & Company, P.C.
99.1 Certifications of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S. C. Section 1350
- ----------
(1) Incorporated herein by reference into this document from the
Exhibits to Form S-1, Registration Statement and amendments thereto,
initially filed on March 10, 2000, Registration No. 333-32146
(2) Incorporated herein by reference into this document from the
Exhibits to the Form 10-Q as filed on November 14, 2002
(3) Incorporated herein by reference into this document from the
Exhibits to the Form 10-K as filed on March 29, 2001
(4) Incorporated herein by reference into this document from the
Exhibits to the Form 8-K as filed on October 18, 2002
(5) Incorporated herein by reference into this document from the
appendix to the proxy statement as filed on December 7, 2000
(b) Reports on Form 8-K
On October 18, 2002, the Company filed a Form 8-K in which it
announced under Item 5 that Michael P. Daly, who previously served as
Executive Vice President of the Company and the Bank, had been appointed
to serve as President, Chief Executive Officer and a Director of the
Company and the Bank and that Lawrence A. Bossidy had been appointed as
Non-Executive Chairman of the Board of Directors of the Company. The 8-K
also indicated that the Company announced that James A. Cunningham, Jr.
resigned as President, Chief Executive Officer and a Director of the
Company and the Bank, effective October 16, 2002. In connection with his
resignation, the Company, the Bank and Mr. Cunningham entered into a
severance agreement to resolve the obligation owed Mr. Cunningham under
his existing employment agreements. The severance agreement and press
release announcing the appointments and Mr. Cunningham's resignation were
attached by exhibit.
On December 18, 2002, the Company filed a Form 8-K in which it
announced under Item 9 three actions related to its long-term business
strategy: (1) the sale of $69.7 million of its sub-prime indirect
automobile loan portfolio to Crescent Bank & Trust; (2) the intent to sell
its current inventory of repossessed automobiles at wholesale; and (3) the
restructuring of its investment portfolio and sale of equity securities.
The press release announcing these strategic actions was attached by
exhibit.
- 99 -
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Berkshire Hills Bancorp, Inc.
Date: March 17, 2003 By: /s/ Michael P. Daly
------------------------------------
Michael P. Daly
President, Chief Executive Officer
and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ Michael P. Daly President, Chief Executive Officer March 17, 2003
- ------------------------------------------- and Director
Michael P. Daly (principal executive officer)
/s/ Wayne F. Patenaude Senior Vice President, Treasurer March 17, 2003
- ------------------------------------------- and Chief Financial Officer
Wayne F. Patenaude (principal accounting
and financial officer)
/s/ Robert A. Wells Chairman of the Board March 17, 2003
- -------------------------------------------
Robert A. Wells
/s/ Lawrence A. Bossidy Non-Executive Chairman March 17, 2003
- -------------------------------------------
Lawrence A. Bossidy
/s/ Thomas O. Andrews Director March 17, 2003
- -------------------------------------------
Thomas O. Andrews
/s/ Thomas R. Dawson, CPA Director March 17, 2003
- -------------------------------------------
Thomas R. Dawson, CPA
- ------------------------------------------- Director March 17, 2003
A. Allen Gray,Esq.
/s/ John Kittredge Director March 17, 2003
- -------------------------------------------
John Kittredge
/s/ Peter J. Lafayette Director March 17, 2003
- -------------------------------------------
Peter J. Lafayette
/s/ Edward G. McCormick, Esq. Director March 17, 2003
- -------------------------------------------
Edward G. McCormick, Esq.
/s/ Catherine B. Miller Director March 17, 2003
- -------------------------------------------
Catherine B. Miller
/s/ Corydon L. Thurston Director March 17, 2003
- -------------------------------------------
Corydon L. Thurston
/s/ Ann H. Trabulsi Director March 17, 2003
- -------------------------------------------
Ann H. Trabulsi
CERTIFICATION
I, Michael P. Daly, certify that:
1. I have reviewed this annual report on Form 10-K of Berkshire Hills
Bancorp, Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
b. evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within
90 days prior to the filing date of this annual report
(the "Evaluation Date"); and
c. presented in this annual report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a. all significant deficiencies in the design or operation
of the internal controls which could adversely affect
the registrant's ability to record process, summarize
and report financial data and have identified for the
registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 17, 2003 /s/ Michael P. Daly
---------------------------------------
Michael P. Daly
President and Chief Executive Officer
CERTIFICATION
I, Wayne F. Patenaude, certify that:
1. I have reviewed this annual report on Form 10-K of Berkshire Hills
Bancorp, Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
b. evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within
90 days prior to the filing date of this annual report
(the "Evaluation Date"); and
c. presented in this annual report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a. all significant deficiencies in the design or operation
of the internal controls which could adversely affect
the registrant's ability to record process, summarize
and report financial data and have identified for the
registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 17, 2003 /s/ Wayne F. Patenaude
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Wayne F. Patenaude
Senior Vice President, Chief
Financial Officer and Treasurer